\nmajor banks in New York and Philadelphia. Through these correspondent relationships, the Bank can offer a variety of collection and international services.\nWith the installation of three automated teller machines (ATMs) in April of 1983, Bank of Lancaster County was the first financial institution in Lancaster County to join the MAC (Money Access Center) Network. Presently the Bank has 16 ATMs in Lancaster County. The Bank became a participating member of the Plus System in the Fall of 1984. This membership entitles our MAC/Plus cardholders to have access to a nationwide network of over 80,000 ATMs.\nThe Bank introduced Discount Brokerage Service in July, 1983. This service is offered in coordination with Trade Saver, Inc., a subsidiary of PNC Bank Corporation of Philadelphia, Pennsylvania and meets the needs of the commission-conscious, independent-minded investor. In 1992 we began offering mutual funds to customers. We believe these services are important additions to our product line and make a statement about our aggressive attitude in providing financial services for the future.\nThe Bank was given permission to open a Trust Department by the Comptroller of the Currency on May 10, 1971. The Trust Department provides personal and corporate trust services. These include estate planning, administration of estates and the management of living and testamentary trusts and investment management services. Other services available are pension and profit sharing trusts and self-employed retirement trusts. Trust Department assets totaled over $126 million at December 31, 1993.\nOn January 31, 1983, Bank of Lancaster County purchased Town & Country, Inc. which is a vehicle and equipment leasing company operating in Pennsylvania and other states. Its principal office is located at 640 East Oregon Road, Lancaster, PA. Town & Country, Inc. employs thirty (30) people.\nBank of Lancaster County's principal market area is Lancaster County, which continues to be one of the fastest growing counties in Pennsylvania. Lancaster County is now the sixth largest county in Pennsylvania, behind Philadelphia, Allegheny, Montgomery, Delaware and Bucks. Lancaster County, with an area of 946 square miles has a population of approximately 430,000. The county's tradition of economic stability has continued, with agriculture, industry and tourism all contributing to the overall strength of the economy.\nOne of the best agricultural areas in the nation, Lancaster County ranks first among Pennsylvania counties and one of the top 20 farm markets in the country. Lancaster County is also one of the leading industrial areas in the state. The county is considered a prime location for manufacturing, away from congested areas, yet close to major east coast markets. Diversification of industry helps to maintain the economic stability of the county. The unemployment rate of the county in December 1993 was 4.5% which was lower than the state (6.3%) and national (6.4%) levels. Lancaster County, with its many historic sites, well-kept farmlands and the large Amish community has become very attractive to tourists and is one of the top tourist attractions in the U.S.\nThe Bank and its subsidiaries are subject to intense competition in all respects and areas of their business from banks and other financial institutions, including savings and loan associations, finance companies, credit unions and other providers of financial services. There are 15 full-service commercial banks with offices in Lancaster County with some of these banks having branches located throughout the County. The banks range in asset size from approximately $112 million to over $29 billion. Of these banks, eight (8) exceed $700 million in assets and seven (7) of the eight (8) exceed $1.3 billion in total assets. Four (4) banks in our trade area exceed $3.8 billion. Several\nbanks are part of bank holding companies. One bank is part of a bank holding company that has assets in excess of $36 billion while another bank is part of a bank holding company that has over $23 billion in assets. Due to our location, we are in direct competition with the larger banks as well as a number of smaller banks. As of December 31, 1993, the Bank ranked, as measured by total deposits, as the fourth largest in county market share of the banks doing business in Lancaster County. The Bank is not, however, the fourth largest bank in Lancaster County. As of December 31, 1993, the Bank had total assets of over $587 million and ranked ninth on this basis among the commercial banks with offices located in Lancaster County.\nThere has not been a material portion of the Bank's deposits obtained from a single person or a few persons, including federal, state or local governments and agencies thereunder and the loss of any single or any few customers would not have a materially adverse effect on the business of the bank.\nThe Bank has no significant foreign sources or applications of funds.\nAs of December 31, 1993, there were 342 persons employed by Bank of Lancaster County-263 full-time and 79 part-time. These figures listed do not include employees of Town & Country, Inc. which are listed elsewhere in this report.\nBank of Lancaster County, N.A. is subject to regulation and periodic examination by the Comptroller of the Currency. Its deposits are insured by the Federal Deposit Insurance Corporation as provided by law.\nItem 2\n\n\nItem 2 - Properties\nBank of Lancaster County, N.A., in addition to its main office, had at December 31, 1993, a branch network of 19 offices and 2 off-site electronic MAC/ATM installations. All branches are located in Lancaster County with the exception of one office which is located in Chester County. Branches at 7 locations are occupied under leases and at three branches, Bank of Lancaster County owns the building, but leases the land. One off-site MAC/ATM installation is occupied under lease.\nThe Administrative Service Center of Bank of Lancaster County, N.A. is owned in fee by the bank, free and clear of encumbrances.\nThe building occupied by Town & Country, Inc., a wholly owned subsidiary of Bank of Lancaster County, N.A. is owned in fee by Town & Country, Inc., free and clear of encumbrances.\nThe leases referred to above expire intermittently over the years through 2022 and most are subject to one or more renewal options.\nItem 3\nItem 3 - Legal Proceedings\nAs of December 31, 1993, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Corporation or its subsidiaries are a party or of which any of their property is the subject.\nItem 4\nItem 4 - Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1993.\nPart II\nItem 5\nItem 5 - Market for the Registrant's Common Equity and Related Stockholder Matters\nThe common stock of Sterling Financial Corporation is not actively traded. There are 10,000,000 shares of common stock authorized and the total number of shares outstanding as of December 31, 1993 was 2,882,920. As of December 31, 1993, the Corporation had approximately 1,969 holders of record of its common stock. There is no other class of common stock authorized or outstanding. During 1993, the price range of the common stock known to management was $31.50 to $46.00 per share. During the last quarter of 1993, prices known to management were $42.50 to $46.00 per share. The Corporation declared a three-for-two stock split in 1992. The following table reflects the bid and asked prices reported for the common stock at the end of the period indicated and the cash dividends declared on the common stock for the periods indicated. In the absence of an active market, these prices may not reflect the actual market value of Sterling Financial Corporation's stock for the periods reported.\nThe prices used in the previous table represent bid and asked prices furnished by F.J. Morrissey & Company; Prudential Securities; Ryan, Beck & Company; or The National Quotation Bureau.\nSterling Financial Corporation maintains a Dividend Reinvestment and Stock Purchase Plan for eligible shareholders who elect to participate in the plan. A copy of the Prospectus for this plan can be obtained by writing to: Bank of Lancaster County, N.A. Dividend Reinvestment and Stock Purchase Plan, 25 North Duke Street, Lancaster, Pennsylvania 17602.\nItem 6\nItem 6 - Selected Financial Data\nThe following selected financial data should be read in conjunction with the Corporation's consolidated financial statements and the accompanying notes presented elsewhere herein.\nItem 7\nItem 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion provides management's analysis of the consolidated financial condition and results of operations of Sterling Financial Corporation (the Corporation) and subsidiaries, Bank of Lancaster County, N.A. (the Bank) and its subsidiary, Town & Country, Inc. and Sterling Mortgage Services, Inc. (presently inactive). It should be read in conjunction with audited financial statements and footnotes appearing elsewhere in this report.\nResults of Operations Summary\nNet income for 1993 was $7,802,000, an increase of $959,000 or 14% over the $6,843,000 earned in 1992. The results of 1992 were $939,000 or 15.9% higher than the $5,904,000 reported in 1991. Earnings per share on net income amounted to $2.72, $2.43, and $2.12 for the years\nended 1993, 1992 and 1991 respectively. Earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding which were 2,864,200, 2,817,651 and 2,775,778 for 1993, 1992 and 1991 respectively. Figures prior to 1993 were retroactively restated to reflect a three-for-two stock split in the form of a 50% stock dividend paid in 1992 and a 5% stock dividend paid in December 1993.\nReturn on average total assets was 1.41% in 1993 compared with 1.34% in 1992 and 1.25% in 1991. Return on average stockholders' equity was 16.90% in 1993 compared with 16.99% in 1992 and 16.63% in 1991.\nGrowth in earning assets was the primary factor contributing to the increased earnings for both 1993 and 1992. As of December 31, 1993, earning assets were approximately $522 million compared to $481 million at December 31, 1992 and $445 million at December 31, 1991. Average earning assets for 1993 increased nearly $43 million to approximately $498 million, up 9.5% from the prior year. Similarly, in 1992 average earning assets increased approximately $31 million, up 7.3% from 1991. The current year increase as well as the increase in 1992 was primarily due to increases in both loans and investments.\nAverage interest-bearing liabilities increased nearly $31.5 million or 7.7% in 1993 compared to an increase of nearly $27 million, or 7% in 1992.\nThe increase in average earning assets exceeded the increase in average interest-bearing liabilities in both 1993 and 1992. These increases along with lower cost of funds contributed to strong net interest margins in each period.\nProvision for loan losses increased to $2,430,000 in 1993 from $2,296,000 in 1992. The provision in 1991 was $1,789,000.\nNon-interest income increased $1,053,000 in 1993. This compares to an increase of $1,205,000 in 1992. These increases are primarily a result of mortgage banking activities.\nNon-interest expenses increased $2,126,000 or 11.2% in 1993, up slightly from the comparable period last year. The increase in 1992 over 1991 was $1,927,000 or 11.3%.\nNet Interest Income\nThe primary component of the Corporation's net earnings is net interest income, which is the difference between interest and fees earned on interest-earning assets and interest paid on deposits and borrowed funds. For presentation and analytical purposes, net interest income is adjusted to a taxable equivalent basis. For purposes of calculating yields on tax-exempt interest income, the taxable equivalent adjustment equates tax-exempt interest rates to taxable interest rates as noted in Table 1. Adjustments are made using a statutory federal tax rate of 34% for 1993, 1992 and 1991.\nTable 1 presents average balances, taxable equivalent interest income and expense and the yields earned or paid on these assets and liabilities. The increase in net interest income during 1993 and 1992 was due primarily to increases in average earning assets. Average earning assets increased 9.5% in 1993 and 7.3% in 1992. These increases were primarily funded with interest-bearing liabilities which increased 7.7% in 1993 and 7% in 1992.\nTable 1 - Distribution of Assets, Liabilities and Stockholders' Equity Interest Rates and Interest Differential-Tax Equivalent Yields (Unaudited)\nNet interest income on a fully taxable equivalent increased by $2,673,000 in 1993 compared to an increase of $2,516,000 in 1992. Table 2 indicates that of the increase in 1993, $2,872,000 was the result of increased volumes while $199,000 of the increase was the result of overall rate decreases. Likewise, the increase in 1992 was a result of\nincreased volumes totaling $2,078,000 while $438,000 of the increase was a result of rate decreases.\nTable 2 - Analysis of Changes in Net Interest Income\nThe rate-volume variance analysis set forth in the table below, which is computed on a tax equivalent basis, analyses changes in net interest income for the periods indicated by their rate and volume components.\nFor the year 1993 compared to 1992, loan volumes, on average, increased over $28.3 million and income earned on loans decreased $229,000, tax adjusted. This compares to a volume increase of nearly $13.5 million in 1992 over 1991 with a decrease in income earned on loans amounting to $2,895,000. During both periods compared, the decrease in interest income due to lower rates exceeded the increase in interest income generated by increased volumes of loans.\nLoan demand declined in both 1993 and 1992 due primarily to a slowing economy. Consequently, the loan growth rate was not as great as previous years. However, the loan growth in 1993 was an improvement over 1992. With the decline in loan demand, the Bank increased its holdings in investment securities. The increase in investment securities, on average, was nearly $15.6 million in 1993 compared to nearly $22 million in 1992. As a result of these increased volumes, interest income increased. Table 2 indicates that of the increase in 1993, $1,275,000 was the result of increased volumes while there was a decrease of $1,058,000 due to decreases in rates resulting in a total increase of $217,000. In 1992 interest income increased $900,000.\nInterest-bearing deposits, on average, grew nearly $25 million in 1993. However, the lower cost of funds reflect a decrease in interest\nexpense.\nProvision for Loan Losses\nThe provision for loan losses charged against earnings was $2,430,000 in 1993 compared to $2,296,000 in 1992 and $1,789,000 in 1991. The provision reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Net charge-offs amounted to $650,000 in 1993, $1,296,000 in 1992 and $764,000 in 1991.\nThe provision for loan loss was increased during 1993 in order for the Bank to provide an adequate reserve based on the evaluation of individual loans and their current characteristics and current economic condition. The reserve accordingly was increased to 2.00% of net loans outstanding from 1.55%. Net charge-offs for the year 1994 should range between $700,000 and $1,300,000. Additions to the loan loss provision are expected to be between $800,000 and $1,400,000.\nNon-Interest Income\nNon-interest income, recorded as other operating income, consists of income from fiduciary activities, service charges on deposit accounts, other service charges, commissions and fees, mortgage banking income and other income such as safe deposit box rents and income from operating leases.\nIncome from fiduciary activities in the amount of $639,000 in 1993 was $43,000 or 7.2% over the $596,000 recorded in 1992. Income in 1992 was $28,000 or 5% greater than the $568,000 recorded in 1991.\nService charges on deposit accounts increased to $1,891,000, an increase of $10,000 or .5% over 1992 service charge income of $1,881,000. The increase in 1993 income resulted primarily from a higher volume of activity on certain deposit transactions. Service charges on deposit accounts in 1992 exceeded the 1991 income of $1,654,000 by $227,000 or 13.7%.\nOther service charges, commissions and fees amounted to $1,577,000 in 1993 compared to $1,370,000 in 1992 and $1,234,000 in 1991. A major contributor to the increase in 1993 was certain fees relating to VISA operations as well as fees generated from mutual funds sales, a new product introduced in 1992.\nIncome from mortgage banking activities in the amount of $2,435,000 increased $934,000 over 1992.\nOther operating income decreased $122,000 to $2,429,000 in 1993 from $2,551,000 in 1992. Other income for 1991 was $2,349,000. A major contributor to other operating income is income generated from operating leases.\nInvestment securities transactions reflect a gain of $8,000 in 1993 compared to $27,000 in 1992 and $3,000 in 1991. The gains listed for these years resulted when certain securities were called at a premium. Securities had been written to par when calls were made thus generating a gain on the securities called. There were no securities sold for the periods listed.\nAs a result of the above, total other operating income increased $1,053,000 in 1993 over 1992 compared to an increase of $1,205,000 in 1992 over 1991.\nNon-Interest Expense\nNon-interest expense consists of salaries and employee benefits, net occupancy expense, furniture and equipment expense and other operating expenses.\nTotal operating expenses for 1993 were $21,048,000 compared to $18,922,000 in 1992. This represented an increase of $2,126,000 or 11.2%. This compares to an increase of $1,927,000 or 11.3% in 1992.\nSalaries and employee benefits expense increased to $11,566,000 in 1993 or $1,212,000 (11.7%) over the $10,354,000 reported in 1992. In 1992, expenses increased $1,096,000 (11.8%) over the $9,258,000 reported in 1991. The increase in 1993 and 1992 was primarily due to increases in staff as well as increases in wages and increased costs of employee benefits.\nBeginning in 1993, Sterling adopted Financial Accounting Standards Board Standard No. 106 - Employer's Accounting for Postretirement Benefits Other than Pensions. Under SFAS No. 106, the cost of postretirement benefits other than pensions must be recognized on an accrual basis as employees perform services to earn the benefits. This is a significant change from the previous generally accepted practice of accounting for these benefits which was on a cash basis. As a result of the adoption of the Standard No. 106, an additional expense of $192,060 was required to comply with the Standard.\nOccupancy expense increased $136,000 or 11.2% to $1,355,000 in 1993 from $1,219,000 in 1992. By comparison, during 1992, there was an increase of $223,000 or 22.4%. A new branch was opened in late 1991 and one was opened in early 1992. This contributed to the increase in 1992. Two new branch facilities were added in late 1993. One of the facilities was a branch relocation.\nFurniture and equipment expenses were $1,253,000 for 1993 and $1,177,000 for 1992. This represents an increase of $76,000 or 6.5%. Reflected in this increase is an increase of depreciation expense in 1993 amounting to $39,000. Expenses in 1992 were $87,000 greater than those recorded in 1991.\nAnother contributor to the increase in total other operating expenses was the increase in the assessment for FDIC insurance. The assessment for 1993 was $1,052,000 which was $68,000 or 6.9% greater than the $984,000 reported in 1992. The assessment in 1992 was $143,000 or 17% greater than the $841,000 reported in 1991. The Bank expects continued costly increases in the assessment rate as the Federal Deposit Insurance Corporation attempts to maintain the solvency of the bank insurance fund.\nOther operating expenses increased $634,000 or 12.2% in 1993 compared to an increase of $378,000, or 7.9% in 1992. The increase noted in both years is in line with rising costs associated with acquiring services covered in this category of expense. Expenses covered in this category include postage, PA Shares Tax, advertising and marketing, professional services, telephone, stationery and forms, ATM fees, Visa fees, insurance premiums and other expense categories not specifically identified on the income statement.\nIncome Taxes\nIncome tax expense totaled $2,749,000 in 1993 compared to $2,331,000 in 1992 and $1,929,000 in 1991. These increases result from higher levels of taxable income and increased earnings each year. The Corporation's effective tax rate was 26.1% in 1993 compared with 25.4% in 1992 and 24.6% in 1991.\nFinancial Condition\nInvestment Portfolio\nTable 3 - Investment Securities at Cost\nThe following table shows the carrying value of Sterling Financial Corporation's investment portfolio as of the dates indicated. Investment securities are stated at cost adjusted for amortization of premiums and accretion of discounts.\nTable 4 - Investment Securities (Yields)\nThe following table shows the maturities of debt securities at carrying value as of December 31, 1993 and weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% federal income tax rate.\nLoans\nTable 5 - Loan Portfolio\nTable 6 - Loan Maturity and Interest Sensitivity\nThe following table sets forth the maturity and interest sensitivity of the loan portfolio as of December 31, 1993:\nLoans due after one year totaling $45,661,000 have variable interest rates. The remaining $32,472,000 in loans have fixed rates.\nTable 7 - Nonaccrual, Past Due and Restructured Loans\nThe following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans:\nThe general policy has been to cease accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest income on these loans is only recognized to the extent payments are received. Loans on a nonaccrual status amounted to $2,960,000 at December 31, 1993 compared to $4,129,000 at December 31, 1992. If interest income had been recorded on all such loans for the years indicated, such interest income\nwould have been increased by approximately $267,295 and $293,967 for 1993 and 1992 respectively. Interest income recorded on the nonaccrual loans in 1993 and 1992 was none and $47,858 respectively. Potential problem loans are loans which are included as performing loans, but for which possible credit problems of the borrower causes management to have doubts as to the ability of such borrower to comply with present repayment terms and which may eventually result in disclosure as a non- performing loan. At December 31, 1993 there were commercial loans to two related borrowers aggregating $1.6 million which were considered as potential problem loans which were not included as nonaccrual loans.\nAt December 31, 1993, there were no concentrations exceeding 10% of total loans. A concentration is defined as amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by changes in economic or other conditions. There were no foreign loans outstanding at December 31, 1993.\nAllowance for Loan Losses\nTable 8 - Summary of Loan Loss Experience\nThe provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and inherent risk to the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Management had not allocated specific portions of the allowance to specific loan categories prior to 1993. Table 9 reflects the allocation at December 31, 1993. Management regularly\nmonitors the creditworthiness and financial condition of its borrowers and does not anticipate any material changes in the net charge-offs in any loan category during the next full year of operations.\nTable 9 - Allocation of Allowance for Loan Losses\nDeposits\nTable 10 - Average Deposit Balances and Rates Paid\nThe average amounts of deposits and rates paid for the years indicated, are summarized below:\nTable 11 - Deposit Maturity\nThe maturities of time deposits of $100,000 or more at December 31, 1993 are summarized below:\nCapital\nStockholders' equity increased by nearly $6.7 million or 15.6% in 1993 to $49,467,000. Total stockholders' equity at December 31, 1992 in the amount of $42,794,000 represents an increase of $5,057,000 or 13.4% over the $37,737,000 reported at December 31, 1991. Strong earnings as well as capital acquired through stock issued pursuant to a dividend reinvestment and stock purchase plan and employee stock plan generated this fine growth in stockholders' equity. Dividends declared amounted to $2,985,000, $2,575,000 and $2,245,000 for 1993, 1992 and 1991 respectively. In 1989, federal regulatory authorities approved risk-\nbased capital guidelines applicable to banks and bank holding companies in an effort to make regulatory capital more responsive to the risk exposure related to various categories of assets and off-balance sheet items. These new guidelines required that banking organizations meet a minimum risk-based capital by December 31, 1992 and redefine the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of capital requirements. The components of capital are called Tier 1 and Tier 2 capital. Tier 1 capital is the shareholders' equity and Tier 2 capital is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-weighted assets. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet items. Required minimum levels of risk-adjusted capital were phased in during the time period December 31, 1990 and December 31, 1992. During this period, the minimum for Tier 1 capital was 3.625% and the total capital ratio minimum was 7.25%. Sterling's ratios at December 31, 1992 and 1991 were above the final risk-based capital standards which had to be reached by December 31, 1992 that require Tier 1 capital of at least 4% and total capital of 8% of risk-weighted assets. The Tier 1 capital ratio at December 31, 1993 was 10.67% and the total capital ratio was 11.92%, which exceeds the minimum capital guidelines. Tier 1 capital ratio was 10.04% and the total capital ratio was 11.29% at December 31, 1992 while Tier 1 capital ratio was 9.71% and the total capital ratio was 10.84% at December 31, 1991.\nTable 12 - Capital and Performance Ratios\nThe following are selected ratios for the years ended December 31:\nLiquidity and Interest Rate Sensitivity\nLiquidity is the ability to meet the requirements of customers for loans and deposit withdrawals in the most economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost. Liquidity from asset categories is provided through cash, noninterest-bearing and interest-bearing deposits with banks, federal funds sold and marketable investment securities maturing within one year. Securities maturing within one year amounted to $22,701,000 at December 31, 1993 compared to $20,767,000 at December 31, 1992. Interest-bearing deposits with banks totaled $40,000 at December 31, 1993 compared to $900,000 at December 31, 1992. Federal funds sold was $12,350,000 and $3,200,000 at December 31, 1993 and 1992 respectively. The loan portfolio also provides an additional source of liquidity due to the Bank of Lancaster County participating in the secondary mortgage market. Sales of residential mortgages into the secondary market of approximately $72 million and $53 million respectively for 1993 and 1992 provided funding which allowed the bank to meet the needs of customers for new mortgage financing. A favorable low interest rate environment in 1993 resulted in significant mortgage loan refinancing which increased liquidity within the bank's loan portfolio. Mortgage loans held for investment and non-conforming for secondary market sale in the amount of approximately $5.5 million were refinanced and sold on the secondary market. Additional liquidity is provided by other sources such as maturing loans.\nOn the liability side, liquidity is available through customer deposits. Federal funds purchased and other forms of short term borrowings are also sources of liquidity.\nLiquidity must constantly be monitored because future customer demands for funds are uncertain. The amount of liquidity needed is determined by the changes in levels of deposits and in the demand for loans. Management believes that the sources of funds mentioned above provide the liquidity to meet customer demands for funds.\nInterest sensitivity is related to liquidity because each is affected by maturing assets and sources of funds. Interest sensitivity, however, is also concerned with the fact that certain types of assets and liabilities may have interest rates that are subject to change prior to maturity. Management endeavors to manage the exposure of the net interest margin to interest-sensitive assets and liabilities so as to minimize the impact of fluctuating interest rates on earnings.\nThe Bank of Lancaster County's asset/liability committee manages interest rate risk by various means including \"GAP\" management of its asset and liability portfolios.\nThe Bank has various investments structured to change investment yield with current market conditions. Assets subject to repricing include federal funds sold (repricing daily), loans tied to \"Treasury Bill\" indexes (repricing monthly) and loans tied to \"prime\" or other indexes subject to immediate change. In addition to assets currently available for repricing there are future scheduled principal repayments on loans, loans available for repricing at future dates and maturities of investments. These investment repayments will have to be reinvested at current market yields.\nThe Bank's funding liabilities repricing has become more complex, since deposit products that historically were rate insensitive have become repriceable liabilities. Time deposits and debt instruments are repriceable at maturity. Other interest bearing liabilities are subject to interest rate change, but not subject to rate change to the same degree as asset repricing. To compensate for this inequality in repricing, historic correlations between \"prime\" rate changes and deposit rate changes are calculated for each deposit product. The resulting pricing correlation is then used to adjust deposit product balances to an interest sensitive equivalent balance. For example, money market deposits have an 80% pricing correlation to an equivalent change in \"prime\". Therefore, 80% of these balances are considered interest rate sensitive in asset/liability management. NOW Accounts have a 39% pricing correlation to \"prime\" and 39% of these balances are considered interest rate sensitive. The pricing correlation is based on relevant past events and is refined monthly.\nInterest repricing of assets and liabilities is measured over future time periods (interest rate sensitivity gaps). While all time gaps are measured, the Bank's primary focus is the cumulative gaps through six months, as these gaps directly affect net interest income in the short time horizon and are harder to make reactive adjustment to actual interest rate movements.\nExcluded from the interest rate sensitivity gaps are \"matched\" funded fixed rate leases and associated fixed rate debt totaling $17.8 million.\nTable 13 - Interest Rate Sensitivity Gaps\nNew Financial Accounting Standards\nThe Financial Accounting Standards Board (FASB) issued Standard No. 112 which establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. This standard is effective for fiscal years beginning after December 15, 1993. Sterling Financial Corporation has determined that the application of this standard will not have a material effect on earnings.\nFASB Statement No. 114 addresses the accounting by creditors for impairment of a loan by specifying how allowances for credit losses related to certain loans should be determined. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. This statement shall be effective for financial statements for fiscal years beginning after December 15, 1994. Sterling has not completed the complex analysis required to estimate the impact of this statement.\nThe Financial Accounting Standard Board issued Standard No. 115 which addresses the accounting and reporting for certain investments in debt securities and equity securities. It requires that these securities be classified into one of three categories: held-to-maturity, available-for-sale, or trading. Specific accounting treatments apply to each of the three categories. Securities held-to-maturity will be reported at amortized cost, trading securities are reported at fair value, with unrealized gains and losses included in earnings and available-for-sale will be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. The statement shall be effective for fiscal years beginning after December 15, 1993. Sterling will apply this statement beginning January 1, 1994 at which time securities will be categorized as required.\nThe Financial Accounting Standards Board issued Standard No. 116. This Statement establishes standards of financial accounting and reporting for contributions received and contributions made. This Statement shall be effective for financial statements issued for fiscal\nyears beginning after December 15, 1994 and interim periods within those fiscal years. Sterling has determined that the application of this standard will not have a material effect on earnings.\nItem 8\n\nItem 8 - Financial Statements and Supplementary Data\n(a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:\n(b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages:\nTrout, Ebersole & Groff Certified Public Accountants 1705 Oregon Pike Lancaster, Pennsylvania 17601 (717)569-2900 FAX (717) 569-0141\nIndependent Auditors' Report\nBoard of Directors and Shareholders Sterling Financial Corporation and Subsidiaries Lancaster, Pennsylvania\nWe have audited the accompanying consolidated balance sheets of Sterling Financial Corporation and Subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sterling Financial Corporation and Subsidiaries at December 31, 1993 and 1992 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nTrout, Ebersole & Groff\nTrout, Ebersole & Groff Certified Public Accountants\nJanuary 21, 1994 Lancaster, Pennsylvania\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSterling Financial Corporation and Subsidiaries\nNote 1 - Formation of Sterling Financial Corporation\nAs a result of a plan of reorganization, The First National Bank of Lancaster County, now by name change, Bank of Lancaster County, N.A. (Bank), became the wholly owned subsidiary of Sterling Financial Corporation (Parent Company), a new bank holding company, at the close of business June 30, 1987. Each outstanding share of the Bank's common stock (par value $10.00) was converted into two shares of common stock (par value $5.00) of the Parent Company. The authorized capital of the Parent Company is 10,000,000 shares of common stock.\nNote 2 - Summary of Significant Accounting Policies\nThe accounting and reporting policies of Sterling Financial Corporation and its subsidiaries conform to generally accepted accounting principles and to general practices within the banking industry. The following is a summary of the most significant policies.\nPrinciples of Consolidation - The accompanying consolidated financial statements include the accounts of Sterling Financial Corporation and its wholly owned subsidiaries, Bank of Lancaster County, N.A. and its subsidiary Town & Country, Inc., and Sterling Mortgage Services, Inc. (presently inactive). All significant intercompany transactions have been eliminated in the consolidation.\nInvestment Securities - Investment securities are carried at cost adjusted for amortization of premiums and accretion of discounts, both computed on the constant yield method. Investment securities primarily consist of debt securities which are carried at amortized cost. It is management's intent to hold investment account securities until maturity. Gains and losses on the sale of investment securities are determined on the specific identification basis and are included in Other Operating Income in the Consolidated Statements of Income. Permanent impairments of market value are reflected in the period ascertained. No securities were considered available for sale or held for trading purposes at December 31, 1993 and 1992.\nPremises and Equipment - Premises, furniture and equipment, leasehold improvements, and capitalized leases are stated at cost, less accumulated depreciation and amortization. For book purposes, depreciation is computed primarily by using the straight-line method over the estimated useful life of the asset. Charges for maintenance and repairs are expensed as incurred. Gains and losses on dispositions are reflected in current operations.\nOther Real Estate Owned - Other real estate owned is carried at the lower of cost or an amount not in excess of estimated fair value.\nAllowance for Loan Losses - The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance.\nInterest Income - Interest on installment loans is recognized primarily on the simple interest, actuarial and the rule of seventy- eights methods. Interest on other loans is recognized based upon the principal amount outstanding. The general policy has been to cease accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest income\non these loans is only recognized to the extent payments are received.\nFederal Income Taxes - Applicable income taxes are based on income as reported in the consolidated financial statements. Deferred income taxes are provided for those elements of income and expense which are recognized in different periods for financial reporting and income tax purposes. Statement of Financial Accounting Statements (SFAS) No. 109 - Accounting for Income Taxes, which changes the method of accounting for income taxes, was retroactively applied in 1993 which resulted in a decrease of $310,000 in retained earnings beginning January 1, 1991. Earnings after this date have not been restated since the change is not considered material.\nTrust Department Assets and Income - Trust assets held by the Bank in a fiduciary or agency capacity for customers of the Trust Department are not included in the financial statements since such items are not assets of the Bank. Trust income has been recognized on the cash basis which is not significantly different from amounts that would have been recognized on the accrual basis.\nEarnings per Share - Earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding which were 2,864,200, 2,817,651, and 2,775,778 for 1993, 1992 and 1991 respectively, after giving retroactive effect to a three-for-two stock split in the form of a 50% stock dividend paid in 1992 and a 5% stock dividend paid in December 1993.\nPresentation of Cash Flows - For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing).\nReclassifications - Certain income items for prior years have been reclassified in order to conform with the current year presentation with no effect to net income.\nNote 3 - Restrictions on Cash and Due From Banks\nThe Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of these reserve balances for the year ended December 31, 1993 was approximately $6,658,000. Balances maintained at the Federal Reserve Bank are included in cash and due from banks.\nNote 4 - Investment Securities\nSecurities pledged to secure government and other public deposits, trust deposits, short-term borrowings, and other balances as required or permitted by law were carried at $28,295,144 in 1993 and $22,463,103 in 1992. The amortized cost and estimated market values of investment securities are as follows:\nThe balance sheet lists Investment Securities by major categories while certain footnotes or tables list mortgage-backed securities as a separate category. Mortgage-backed securities are either Obligations of Other U.S. Government Agencies or Other (Corporate) Securities. In 1993, such securities were listed at $5,834,000 of which $5,023,000 were Obligations of Other U.S. Government Agencies and $811,000 were listed in Other Securities. In 1992, $7,175,000 were listed as mortgage-backed securities of which $6,552,000 were Obligations of Other U.S. Government Agencies and $623,000 were listed in Other Securities.\nThe amortized cost and estimated market value of debt securities at December 31, 1993, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThere were no sales of investments in debt securities during 1993, 1992 or 1991.\nNote 5 - Loans\nLoans on a non-accrual status amounted to $2,960,038 at December 31, 1993, compared to $4,129,295 at December 31, 1992. If interest income had been recorded on all such loans for the years indicated, such interest income would have increased by approximately $267,295 and $293,967 for 1993 and 1992 respectively.\nNote 6 - Allowance for Loan Losses\nChanges in the Allowance for Loan Losses were as follows:\nNote 7 - Premises and Equipment\nDepreciation expense amounted to $983,345 in 1993, $940,843 in 1992 and $854,252 in 1991.\nNote 8 - Other Assets\nIncluded in other assets for 1993 and 1992 is $17,186,239 and $16,809,324 respectively which represents operating leases generated by Town & Country, Inc. The income generated from the leases for 1993 and 1992 amounted to $1,736,814 and $1,824,796 respectively and is reflected in other operating income.\nThe following schedule provides an analysis of Town & Country's investment in property on operating leases and property held for lease by major classes as of December 31, 1993 and 1992:\nNote 9 - Time Certificates of Deposit\nAt December 31, 1993 and 1992, time certificates of deposit of $100,000 or more aggregated $13,159,166 and $13,681,887 respectively.\nNote 10 - Other Liabilities for Borrowed Money\nThe following represents other liabilities for borrowed money at December 31:\nLiabilities in connection with Town & Country, Inc. leasing operations are payable to various lenders at various terms. The estimated current portion of this debt is $8,027,368 at December 31, 1993. The borrowings from the Federal Home Loan Bank of Pittsburgh consist of two advances in 1993. One in the amount of $621,450, bears interest monthly at the rate of 4.49% per year and matures July 29, 1996. The second, in the amount of $950,000 bears interest at the rate of 5.39% per year and matures September 13, 2000.\nNote 11 - Mortgages Payable and Capitalized Lease Liability\nThe Bank entered into a transaction with the Lancaster Industrial Development Authority in 1976 through The First Federal Savings and Loan Association of Lancaster, which became Penn Savings Bank, which has now become Sovereign Bank, to finance the construction of the Millersville office. The balance on this obligation was $85,292 on December 31, 1992. This obligation was paid in full in 1993. The rate of interest was 7 1/2%.\nIn 1978, the Bank entered into another transaction with the Lancaster Industrial Development Authority through The First Federal Savings and Loan Association of Lancaster, which became Penn Savings Bank, which has now become Sovereign Bank, to purchase the building for our Duke Street (Lancaster) Office. The balance on this obligation was $109,844 on December 31, 1992. This obligation was paid in full in 1993. The rate of interest was 7%.\nThe Bank leases the Fruitville Pike Office building. This lease was entered into in 1979. This is a capitalized lease and is accounted for and depreciated as bank-owned property, with lease payments accounted for as interest and debt reduction. The obligation under capitalized lease liability amounted to $11,188 on December 31, 1993 and $23,350 on December 31, 1992. Lease payments amount to $1,676 monthly of which $1,175.61 is applied as interest and debt reduction and the remaining $500.39 is for land rental and treated as an operating lease. The term of this lease is 15 years with renewal options available.\nThe following is a schedule of the total future minimum lease payments together with the present value of the net minimum lease payments related to the capitalized lease payments as of December 31, 1993.\nNote 12 - Pension and Employee Stock Bonus Plan\nThe Bank of Lancaster County, N.A. and its subsidiary, Town & Country, Inc. maintains a qualified non-contributory pension plan for their employees. The Plan specifies fixed benefits to provide a monthly pension benefit at age 65 for life (with payments guaranteed for 10 years) equal to one and one-half percent of each participant's final average salary (highest five consecutive years' base compensation preceding retirement) for each year of credited service. All employees with one year of service who work at least 1,000 hours per year and who are at least age 21 are eligible to participate. A participant becomes 100% vested upon completion of five years of service.\nSterling Financial Corporation has adopted the provision of Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\", for the year ended December 31, 1987. The net periodic pension cost for 1993, 1992 and 1991 was $574,627, $328,019 and $257,444 respectively.\nNet periodic pension cost for 1993, 1992 and 1991 included the following:\nThe weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 6.5% and 5%, respectively, at December 31, 1993. The expected long-term rate of return on plan assets in 1993 was 9%.\nThe Board of Directors of the Bank adopted an employee stock plan effective July 1, 1981. The assets of the Plan will be entirely invested in Sterling Financial Corporation common stock. The Plan covers all Bank employees who are age 18 and over, are employed for at least 1,000 hours per year and have completed at least one year of service. The Plan has two parts:\n*The Thrift Incentive portion of the Plan permits any eligible participant to make voluntary contributions to the Plan ranging from 2% to 6% of compensation. The Bank will contribute 25% of what the participant contributes. This portion of the Plan is intended to encourage thrift and investment in Sterling Financial Corporation stock.\n*The Performance Incentive portion of the Plan allows the Bank to make annual contributions to the Plan based on certain overall Bank performance objectives. These contributions will be allocated to the participants based on compensation.\nBank contributions to the Plan vest in each participant's account at the rate of 20% for each year of service. Normally, benefits may be paid from the Plan on retirement, termination, disability or death. Participants in the Plan may withdraw their own contribution earlier under several restricted conditions of hardship with approval of the Plan Committee. The Plan provides that each participant may vote the shares in his or her account through the Plan Trustee at any shareholder meeting. The Bank of Lancaster County Trust Department serves as Trustee for the Plan. All dividends received on Sterling Financial Corporation stock are reinvested in additional shares of Sterling Financial Corporation stock.\nThe contribution to the Performance Incentive portion of the Plan was $200,000, $165,000 and $150,000 for 1993, 1992 and 1991 respectively. The contribution to the Thrift Incentive portion of the Plan was $41,766 in 1993, $37,291 in 1992 and $32,685 in 1991.\nNote 13 - Applicable Income Taxes\nThe effective income tax rates for financial reporting purposes are less than the Federal statutory rate of 34% for 1993, 1992 and 1991 for reasons shown as follows:\nThe Financial Accounting Standards Board has issued Statement No. 109, Accounting for Income Taxes, which significantly changes the recognition and measurement of deferred income tax assets and liabilities. Statement 109 requires that deferred income taxes be recorded on an asset/liability method and adjusted when new tax rates are enacted. The Company adopted Statement No. 109 beginning with its year ending December 31, 1993. The Statement provides that the effect of its adoption may be recorded entirely in the year of adoption retroactively by restating one or more prior years. The statement was retroactively applied in 1993.\nNote 14 - Operating Leases\nThe Bank leases certain banking facilities under operating leases which expire on various dates to 2022. Renewal options are available on these leases. Minimum future rental payments as of December 31, 1993 are as follows:\nTotal rent expense charged to operations amounted to $373,332 in 1993, $334,654 in 1992 and $282,760 in 1991.\nNote 15 - Disclosures about Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.\nCash and Short-Term Investments- For those short-term instruments, the carrying amount is a reasonable estimate of fair value.\nInvestment Securities- For investment securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.\nLoans- For certain homogenous categories of loans, such as some residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Lease contracts as defined in FASB Statement No. 13, Accounting for Leases, are not included in this disclosure statement.\nDeposit Liabilities- The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities.\nU.S. Treasury Demand Notes- For U.S. Treasury demand notes, the carrying amount is a reasonable estimate of fair value.\nOther Borrowings- Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.\nCommitments to Extend Credit and Standby Letters of Credit- The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.\nThe estimated fair values of the Corporation's financial instruments are as follows:\n* The amounts shown under \"Carrying Amount\" represent accruals or deferred income (fees) arising from those unrecognized financial instruments.\nNote 16 - Commitments and Contingent Liabilities\nIn the normal course of business, there are various commitments and contingent liabilities which are not reflected in the financial statements. These include lawsuits and commitments to extend credit, guarantees and letters of credit. In the opinion of management, there are no material commitments which represent unusual risks.\nA summary of the more significant commitments as of December 31, 1993 and 1992 are as follows:\nSummary of Quarterly Financial Data (Unaudited) Sterling Financial Corporation and Subsidiaries\nThe following is a summary of the quarterly results of operations for the years ended December 31, 1993 and 1992. Net income per share of common stock has been restated to retroactively reflect a three-for-two stock split in the form of a 50% stock dividend paid in 1992 and a 5% stock dividend in 1993.\nItem 9\nItem 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 10\n\n\nItem 10 - Directors and Executive Officers of the Registrant\nIncorporated by reference is the information appearing under the heading \"Information about Nominees and Continuing Directors\" on pages 5 and 6 of the 1994 Proxy Statement and under the heading \"Officers and Executive Officers\" on page 7 of the 1994 Proxy Statement.\nItem 11\nItem 11 - Executive Compensation\nIncorporated by reference is the information under the heading \"Compensation of Directors\" on page 11 of the 1994 Proxy Statement and under the heading \"Executive Compensation\" on page 7 of the 1994 Proxy Statement.\nItem 12\nItem 12 - Security Ownership of Certain Beneficial Owners and Management\nIncorporated by reference is the information appearing under the heading \"Voting of Shares of Principal Holders Thereof\" on page 3 of the 1994 Proxy Statement and under the heading \"Information about Nominees and Continuing Directors\" on pages 5 and 6 of the 1994 Proxy Statement.\nItem 13\nItem 13 - Certain Relationships and Related Transactions\nIncorporated by reference is the information appearing under the heading \"Transactions with Directors and Executive Officers\" on page 12 of the 1994 Proxy Statement and under \"Notes to Consolidated Financial Statements - Note 17 - Related Party Transactions\" on page 34 of the Form 10-K for the year ended December 31, 1993.\nPART IV\nItem 14\nItem 14 - Exhibits, Financial Statement Schedules and Reports of Form 8-K\n(a) The following documents are filed as part of this report:\n1. The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report.\n2. Financial Statement Schedules\nAll schedules are omitted because they are not applicable, the data are not significant or the required information is shown in the financial statements or the notes thereto or elsewhere herein.\n3. Exhibits\nThe following is a list of the Exhibits required by Item 601 of Regulation S-K and are incorporated by reference herein or annexed to this Annual Report.\n1. Articles of Incorporation and Bylaws of Sterling Financial Corporation incorporated by reference to Exhibit 3 of Registration Statement on Form S-4 (No. 33-12635) filed with the\nSecurities and Exchange Commission on March 13, 1987.\n2. Material Contracts - Employment Agreement of John E. Stefan, President and Chief Executive Officer of Sterling Financial Corporation and Bank of Lancaster County, N.A. - incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September 30, 1987.\n3. List of Subsidiaries\n4. Consent of Auditors\n(b) Reports on Form 8-K\nA report on Form 8-K dated October 26, 1993 was filed during the third quarter of 1993 pursuant to Item 5 of Form 8-K relating to a 5% stock dividend declared on October 26, 1993, to shareholders of record, November 17, 1993 and payable December 6, 1993.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSTERLING FINANCIAL CORPORATION\nBy: John E. Stefan President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.\nSignature Title\nJOHN E. STEFAN President and Chief (John E. Stefan) Executive Officer; Director\nRONALD L. BOWMAN Secretary/Treasurer (Ronald L. Bowman)\nRICHARD L. ALBRIGHT, JR. Director (Richard H. Albright, Jr.)\nJOHN E. BURKHOLDER Director (John E. Burkholder)\nROBERT H. CALDWELL Director (Robert H. Caldwell)\nHOWARD E. GROFF, JR. Director (Howard E. Groff, Jr.)\nJ. ROBERT HESS Director (J. Robert Hess)\nCALVIN G. HIGH Director (Calvin G. High)\nE. GLENN NAUMAN Director (E. Glenn Nauman)\nGLENN R. WALZ Director (Glenn R. Walz)\nTrout, Ebersole & Groff Certified Public Accountants 1705 Oregon Road Lancaster, Pennsylvania 17601 (717) 569-2900 FAX (717) 569-0141\nExhibit 24\nConsent of Independent Certified Public Accountants\nWe hereby consent to the incorporation by reference in Registration Statement No. 33-16049 on form S-3 filed July 24, 1987 of our opinion dated January 21, 1994, on the consolidated financial statements of Sterling Financial Corporation for the year ended December 31, 1993 as set forth in this Form 10-K.\nTROUT, EBERSOLE & GROFF\nTrout, Ebersole & Groff Certified Public Accountants\nLancaster, Pennsylvania March 8, 1994"},"word_count":{"kind":"number","value":9911,"string":"9,911"},"character_count":{"kind":"number","value":63788,"string":"63,788"}}},{"rowIdx":278,"cells":{"filename":{"kind":"string","value":"723916_1993.txt"},"id":{"kind":"string","value":"723916_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"723916"},"text":{"kind":"string","value":"ITEM 1.\nMeridian Bancorp, Inc.\nMeridian Bancorp, Inc. (the \"Registrant\"), a multi-bank holding company registered under the federal Bank Holding Company Act of 1956, as amended, was incorporated as a Pennsylvania business corporation as a result of the statutory consolidation on June 30, 1983 of American Bancorp, Inc. and Central Penn National Corp. The Registrant's subsidiaries presently engaged in the business of banking are (i) Meridian Bank, formed in 1986 as a result of the merger of the Registrant's then-existing three banking subsidiaries (American Bank and Trust Co. of Pa., Central Penn National Bank and The First National Bank of Allentown), (ii) Delaware Trust Company, acquired in January 1988, and (iii) Meridian Bank, New Jersey, which commenced operations in April 1993 upon the acquisition of Cherry Hill National Bank.\nRecent Transactions\nOn August 31, 1993, the Registrant acquired Commonwealth Bancshares Corporation (\"Commonwealth\"), a bank holding company headquartered in Williamsport, Pennsylvania. The acquisition was accounted for as a \"pooling of interests\" and constituted a tax- free exchange for federal income tax purposes. Concurrently with the transaction, Commonwealth Bank, the sole banking subsidiary of Commonwealth, was merged into Meridian Bank. At August 31, 1993, Commonwealth had total consolidated assets of approximately $2.2 billion and total deposits of approximately $1.6 billion.\nOn April 26, 1993, in connection with the acquisition of Commonwealth, the Registrant agreed to a merger of The Grange National Bank of Susquehanna County (\"Grange\"), a two-branch national bank headquartered in New Milford, Pennsylvania, into Meridian Bank. At December 31, 1993, Grange had approximately $28.5 million in total assets and $25.3 million in total deposits. The acquisition is expected to be accounted for as a \"pooling of interests\" and to constitute a tax-free exchange for federal income tax purposes. The acquisition is expected to be completed in the second quarter of 1994. The Registrant will issue up to 166,500 shares of Common Stock in connection with the merger.\nIn November 1993, Meridian Bank assumed approximately $76 million of deposits of Provident Savings Bank of Jersey City, and paid a premium of $540 thousand. This acquisition was accounted for as a purchase.\nOn December 10, 1993, the Registrant acquired First Bath Corp. (\"FBC\"), a bank holding company headquartered in Bath, Pennsylvania. The acquisition was accounted for as a \"pooling of interests\" and constituted a tax-free exchange for federal income tax purposes. Concurrently with the transaction, The First National Bank of Bath, FBC's sole subsidiary, was merged into Meridian Bank. At December 10, 1993, FBC had total consolidated assets of approximately $120 million and total consolidated deposits of approximately $110 million.\nOn December 16, 1993, the Registrant entered into a definitive agreement to acquire McGlinn Capital Management, Inc., an investment advisory firm with $2.8 billion in assets under direct management, for 500,000 warrants for shares of the Registrant's Common Stock and cash. The transaction, which is subject to regulatory approval, is expected to be completed by the end of the second quarter of 1994.\nBank Subsidiaries - Meridian Bank, Delaware Trust Company and Meridian Bank, New Jersey\nMeridian Bank conducts its business principally through 269 banking offices located in 29 eastern and central Pennsylvania counties.\nDelaware Trust, a Delaware banking corporation, was incorporated in 1899 under the Delaware General Corporation Law and acquired banking powers through its merger in 1910 with Delaware Savings Bank, which was created in 1905 by a special act of the General Assembly of the State of Delaware. Delaware Trust operates 26 branches in New Castle, Kent and Sussex Counties, Delaware.\nIn January 1993, the Registrant caused the formation of Meridian Bank, New Jersey, a New Jersey state-chartered banking institution, to effect the acquisition of Cherry Hill National Bank, which was completed in April 1993. Meridian Bank, New Jersey operates 8 branches in Camden and Burlington Counties, New Jersey.\nAt December 31, 1993, Meridian Bank, Delaware Trust and Meridian Bank, New Jersey had total deposits of $10.1 billion, $1.2 billion and $176 million, respectively, total loans of $8.4 billion, $944 million and $70 million, respectively, and total assets of $12.3 billion, $1.4 billion and $196 million, respectively.\nMeridian Bank, Delaware Trust and Meridian Bank, New Jersey provide a wide variety of services, including secured and unsecured financing, real estate financing, checking, savings and time deposit accounts, as well as the offering of cash management and a variety of other specialized financial services to individuals, businesses, municipalities and other governmental bodies. In addition, Meridian Capital Markets, Inc. a division of Meridian Bank, engages in the underwriting of municipal obligations and various other investment banking, merchant banking, mortgage banking and related activities permitted by law for banks.\nOn July 9, 1992, the Registrant entered into an agreement to acquire 21 branches in seven counties of central and southern New Jersey, of Security Savings Bank, SLA (\"Security\"), a wholly- owned subsidiary of Security Investments Group, Inc. (\"Security Investments\"). Under the terms of the agreement, Meridian Bank, New Jersey was to have acquired selected non-classified and performing assets and real estate having, based on June 30, 1992 data and fair values, a book value of approximately $820 million in exchange for the assumption of deposits and Federal Home Loan Bank borrowings having an aggregate book value of a like amount and the payment of a deposit premium based on the amount of deposit liabilities assumed. On December 4, 1992, Office of Thrift Supervision declared Security insolvent and placed it in conservatorship with the Resolution Trust Company (\"RTC\"). The RTC, in its capacity as receiver of Security, repudiated the agreement in the fourth quarter of 1993 in accordance with its authority under applicable banking law.\nOther Subsidiaries of the Registrant\nMeridian Life Insurance Company is a wholly-owned subsidiary of the Registrant that reinsures life insurance and accident and health insurance issued to borrowers in connection with loans and other extensions of credit made to such borrowers by the Registrant's subsidiary banks.\nMeridian Funding Corp. is a wholly-owned subsidiary of the Registrant that issues commercial paper for the use of the Registrant and its subsidiaries.\nMeridian Asset Management, Inc. (\"MAM\") and its subsidiaries, Meridian Trust Company, Meridian Trust Company of California and Meridian Investment Company, provide services formerly provided by the trust departments of the predecessors of Meridian Bank. These services include personal and corporate trust, asset management and related services and investment advisory services. Meridian Trust Company is a Pennsylvania trust company with full trust powers. Meridian Investment Company is an investment advisory firm registered with the Securities and Exchange Commission and the Pennsylvania Securities Commission. As of December 31, 1993, assets being administered in one or more fiduciary capacities by MAM or one of its subsidiaries had an aggregate market value of approximately $15.5 billion, of which MAM or one of such subsidiaries had sole or joint investment responsibility for approximately $4.4 billion. Meridian Trust Company of California, based in San Francisco, was organized by MAM in 1989 and engages in personal and corporate trust activities in California.\nIn addition to fiduciary services provided by MAM and its subsidiaries, Delaware Trust Capital Management, Inc., a Delaware bank and trust company and a wholly-owned subsidiary of Delaware Trust, performs trust and related financial services. Prior to the commencement of operations by Delaware Trust Capital Management, Inc. in January 1989, such services were performed by the Capital Management Group of Delaware Trust. As of December 31, 1993, assets being administered in one or more fiduciary capacities by Delaware Trust Capital Management, Inc. had an aggregate market value of approximately $12 billion, of which it had sole or joint investment responsibility for approximately $1.7 billion.\nMeridian Securities, Inc. is registered as a broker with the Securities and Exchange Commission and the Pennsylvania Securities Commission and is a member of the National Association of Securities Dealers, Inc.\nMeridian Capital Corp., a wholly-owned subsidiary of the Registrant, is a small business investment company licensed by the SBA, the business emphasis of which is small businesses located in the tri-state area of Pennsylvania, Delaware and New Jersey. This subsidiary is under agreement of sale.\nMeridian Acceptance Corp., a wholly-owned subsidiary of the Registrant, engages in the business of purchasing motor vehicle installment sale contracts originating in the State of New Jersey.\nUntil August 1990, Meridian Mortgage Corporation (\"Meridian Mortgage\") operated as a wholly-owned mortgage banking subsidiary of the Registrant. In August 1990, Meridian Mortgage became a wholly-owned subsidiary of Meridian Bank. Meridian Mortgage was incorporated in mid-1983 and provides a full range of real estate financing services for owners of residential and commercial properties. Meridian Mortgage originates mortgage loans, services residential and commercial mortgages through offices in New Jersey, Pennsylvania, New York, Florida, Washington State and Delaware and securitizes and sells mortgages and servicing in the secondary markets. During the third quarter of 1993, the Registrant decided to significantly reduce the scope of its mortgage banking business through a sale of substantially all of the mortgage servicing operations conducted by Meridian Mortgage.\nMeridian Delaware Investments, Inc., a wholly-owned subsidiary of the Registrant, is a Delaware business corporation that invests in and holds certain investments.\nMeridian Leasing, Inc. specializes in leasing office and business equipment. In October 1991, Meridian Leasing, Inc. was reorganized as a direct subsidiary of Meridian Bank.\nIn November 1989, Meridian Bank formed Meridian Auto Leasing, Inc. This corporation conducts the automobile leasing activities previously conducted by Meridian Bank.\nMeridian Asset Servicing Corp. was formed in 1993 to hold title to real estate acquired through foreclosure on defaulted loans.\nOn June 30, 1992, the Registrant completed the sale of its title insurance operations to Fidelity National Financial, Inc., of Irvine, California.\nSupervision and Regulation\nVarious requirements and restrictions under the laws of the United States and the states in which the Company and its subsidiaries do business affect the Registrant and its subsidiaries.\nGeneral\nThe Registrant is a bank holding company subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\") under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). As a bank holding company, the Registrant's activities and those of its banking and nonbanking subsidiaries are limited to the business of banking and activities closely related or incidental to banking, and the Registrant may not directly or indirectly acquire the ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board.\nThe Registrant's subsidiary banks are subject to supervision and examination by applicable federal and state banking agencies. All of the Registrant's subsidiary banks are insured by, and therefore subject to the regulations of, the Federal Deposit Insurance Corporation (the \"FDIC\"). In addition, Meridian Bank is a Pennsylvania bank and trust company and member of the Federal Reserve System subject to supervision and regulation by the Pennsylvania Department of Banking and the Federal Reserve Board. Delaware Trust Company is a Delaware banking corporation subject to supervision and regulation by the Delaware State Bank Commissioner. Meridian Bank, New Jersey, is a New Jersey state bank subject to supervision and regulation by the New Jersey Department of Banking. The Registrant's subsidiary banks are also subject to requirements and restrictions under federal and state law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon, and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the Registrant's subsidiary banks. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.\nHolding Company Structure\nThe Registrant's subsidiary banks are subject to restrictions under federal law which limit the transfer of funds by each of them to the Registrant and its nonbanking subsidiaries, whether in the form of loans, other extensions of credit, investments or asset purchases. Such transfers by any subsidiary bank to the Registrant or any nonbanking subsidiary are limited in amount to 10% of such subsidiary bank's capital and surplus and, with respect to the Registrant and all nonbanking subsidiaries, to an aggregate of 20% of such subsidiary bank's capital and surplus. Furthermore, such loans and extensions of credit are required to be secured in specified amounts.\nThe Federal Reserve Board has issued regulations under the BHCA that require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve Board, pursuant to such regulations, may require the Registrant to stand ready to use its resources to provide adequate capital funds to its banking subsidiaries during periods of financial stress or adversity. This support may be required at times when, absent such regulations, the bank holding company might not otherwise provide such support. Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"Improvement Act\"), a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become \"undercapitalized\" (as described below) with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency, up to specified limits. Under the BHCA, the Federal Reserve Board has the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve Board's determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.\nUnder the Financial Institutions Reform, Recovery, and Enforcement Act (\"FIRREA\"), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled depository institution in danger of default.\nRegulatory Restrictions on Dividends\nDividend payments by Meridian Bank to the Registrant are subject to the Pennsylvania Banking Code of 1965 (the \"Banking Code\") and the Federal Deposit Insurance Act. Under the Banking Code, no dividends may be paid except from \"accumulated net earnings\" (generally, undivided profits). Under the Federal Deposit Insurance Act, no dividends may be paid by an insured bank if the bank is in arrears in the payment of any insurance assessment due to the FDIC.\nThe declaration and payment of dividends by Delaware Trust to the Registrant are subject to the Delaware Banking Code and the Federal Deposit Insurance Act. Under the Delaware Banking Code, no dividends may be paid except from \"net profits\" (generally, net income as defined under federal regulations and reported to the State Bank Commissioner). Additional restrictions apply unless Delaware Trust's surplus fund is equal to the amount of its common stock.\nThe declaration and payment of dividends by Meridian Bank, New Jersey to the Company are subject to the New Jersey Banking Act of 1948 and the Federal Deposit Insurance Act. Under the New Jersey Banking Act of 1948, Meridian Bank, New Jersey cannot pay a cash dividend unless following such dividend, the Bank's surplus will equal at least fifty percent of the capital stock or the payment of the dividend will not reduce the Bank's surplus.\nState and federal regulatory authorities have adopted standards for the maintenance of adequate levels of capital by banks. Adherence to such standards further limits the ability of banks to pay dividends.\nUnder these policies and subject to the restrictions applicable to the Registrant's subsidiary banks, such subsidiary banks could declare in the remainder of 1994, without prior regulatory approval, aggregate dividends of $147.1 million, plus net profits for the remainder of 1994.\nThe payment of dividends by any subsidiary bank may also be affected by other regulatory requirements and policies, such as the maintenance of adequate capital. If, in the opinion of the applicable regulatory authority a bank under its jurisdiction is engaged in, or is about to engage in, an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions.\nFDIC Insurance Assessments\nOn January 1, 1993, the FDIC began to implement a risk-related premium schedule for all insured depository institutions that will result in the assessment of premiums based on capital and supervisory measures. The risk-related premium schedule was implemented during 1993; the FDIC began implementing a permanent system on January 1, 1994.\nUnder the risk-related premium schedule, the FDIC, on a semiannual basis, will assign each institution to one of three capital groups (well-capitalized, adequately capitalized or undercapitalized) and further assign such institution to one of three subgroups within a capital group corresponding to the FDIC's judgment of its strength based on supervisory evaluations, including examination reports, statistical analysis and other information relevant to assessing the risk characteristics of the institution. Only institutions with a total capital to risk-adjusted assets ratio of 10% or greater, a Tier 1 capital to risk-adjusted assets ratio of 6% or greater and a Tier 1 leverage ratio of 5% or greater, are assigned to the well-capitalized group. Institutions deemed to have the highest risk would pay up to $.31 for every $100 of deposits annually while those deemed to have the least risk would pay $.23 for every $100 of deposits annually. After the risk-based premium schedule is fully phased in, the weakest institutions will face semiannual premium increases until their premium classification is upgraded or they merge with a stronger institution or fail.\nCapital Adequacy\nThe Federal Reserve Board adopted risk-based capital guidelines for bank holding companies, such as the Registrant. The guidelines were phased in over a two-year period ended December 31, 1992. Currently, the required minimum ratio of total capital to risk-weighted assets (including off-balance sheet activities, such as standby letters of credit) is 8%. At least half of the total capital is required to be \"Tier 1 capital,\" consisting principally of common shareholders' equity, noncumulative perpetual preferred stock, a limited amount of cumulative perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill. The remainder (\"Tier 2 capital\") may consist of a limited amount of subordinated debt and intermediate-term preferred stock, certain hybrid capital instruments and other debt securities, perpetual preferred stock, and a limited amount of the general loan loss allowance. During the two-year phase-in period, a limited portion of Tier 2 capital was permitted to be included as Tier 1 capital.\nIn addition to the risk-based capital guidelines, the Federal Reserve Board established minimum leverage ratio (Tier 1 capital to total assets) guidelines for bank holding companies. These guidelines provide for a minimum leverage ratio of 3% for those bank holding companies which have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. All other bank holding companies are required to maintain a leverage ratio of at least 1% to 2% above the 3% stated minimum.\nEach of the Registrant's subsidiary banks is subject to similar capital requirements adopted by its primary federal regulator.\nIn 1993, each of the federal banking agencies, including the Federal Reserve Board and the FDIC, adopted uniform changes to the risk-based capital guidelines with respect to intangibles. Under the new rules, the only types of identifiable intangible assets that may be included in (i.e., not deducted from) an institution's capital are readily marketable purchased mortgage servicing rights (\"PMSRs\") and purchased credit card relationships (\"PCCRs\"), provided that, in the aggregate, the total amount of PMSRs and PCCRs included in capital does not exceed 50% of Tier 1 capital. PCCRs are subject to a separate sublimit of 25% of Tier 1 capital. The amount of PMSRs and PCCRs that an institution may include in its capital is the lesser of (i) 90% of such assets' fair market value (as determined under the guidelines) or (ii) 100% of such assets' book value on a discounted basis, guidelines) or (iii) 100% of such assets' book value on a discounted basis, each determined quarterly. Identifiable intangible assets other than PMSRs and PCCRs, including core deposit intangibles, acquired for purposes of the test applicable to bank holding companies on or before February 19, 1992 (the date the Federal Reserve Board issued its original proposal for public comment) generally will not be deducted from capital for supervisory purposes, although they will continue to be deducted for purposes of evaluating applications filed by bank holding companies.\nOther Provisions of the Improvement Act\nThe Improvement Act required the federal banking agencies to promulgate regulations specifying the levels at which an insured institution would be considered \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" In October 1992, each of the Federal banking agencies issued uniform final regulations defining such capital levels. Under these regulations, a bank will be considered \"well capitalized\" if it has (i) a total risk-based capital ratio of 10% or greater, (ii) a Tier 1 risk-based capital ratio of 6% or greater, (iii) a leverage ratio of 5% or greater and (iv) is not subject to any order or written directive to meet and maintain a specific capital level. An \"adequately capitalized\" bank is defined under the regulations as one that has (i) a total risk-based capital ratio of 8% or greater, (ii) a Tier 1 risk-based capital ratio of 4% of greater, (iii) a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with the highest composite regulatory examination rating) and (iv) does not meet the definition of a well capitalized bank. A bank will be considered (A) \"undercapitalized\" if it has (i) a total risk-based capital ratio of less than 8%, (ii) a Tier 1 risk-based capital ratio of less than 4% or (iii) a leverage ratio of less than 4% (or 3% in the case of a bank with the highest regulatory examination rating of 1); (B) \"significantly undercapitalized\" if the bank has (i) a total risk-based capital ratio of less than 6%, (ii) a Tier 1 risk-based capital ratio of less than 3% or (iii) a leverage ratio of less than 3%; and (C) \"critically undercapitalized\" if the bank has a ratio of tangible equity to total assets of equal to or less than 2%. Notwithstanding the foregoing, the applicable federal bank regulator for a depository institution could, under certain circumstances, reclassify a \"well capitalized\" institution as \"adequately capitalized\" or require an \"adequately capitalized\" or \"undercapitalized\" institution to comply with supervisory actions as if it were in the next lower category. Such a reclassification could be made if the regulatory agency determines that the institution is in an unsafe or unsound condition (which could include unsatisfactory examination ratings).\nUndercapitalized institutions, including significantly and critically undercapitalized institutions, are required to submit capital restoration plans to the appropriate federal banking regulator and are subject to restrictions on operations, including prohibitions on branching, engaging in new activities, paying management fees, making capital distributions such as dividends, and growing without regulatory approval.\nIn May 1992, the FDIC issued regulations implementing provisions of the Improvement Act regulating brokered deposits. \"Brokered deposits\" are defined as deposits solicited through deposit brokers or deposits which an insured depository institution attracts by offering significantly above-market interest rates (as defined). Under the new regulations, \"well capitalized\" banks may accept brokered deposits without restriction, \"adequately capitalized\" banks may accept brokered deposits with a waiver from the FDIC (subject to certain restrictions imposed on payment of rates), while \"undercapitalized\" banks may not accept brokered deposits.\nThe Improvement Act requires each federal banking agency to review, every two years, its capital standards to prevent or minimize loss to the Bank Insurance Fund (the \"BIF\") and the Savings Association Insurance Fund (the \"SAIF\"). Each agency must also revise its risk-based capital standards to ensure that those standards adequately take into account interest-rate risk, concentration of credit risk and risks of nontraditional activities, as well as reflect the actual performance and expected risk of loss on multi-family mortgages. In September 1993, the Federal Reserve Board and the FDIC issued a joint notice of proposed rulemaking seeking public comment on a proposed framework for revisions to the risk-based capital rules to take account of these factors. The proposal offers two alternatives to measure interest rate risk and the corresponding increased capital required as a result thereof. The Registrant is unable to predict the final form in which these proposed regulations will ultimately be adopted or the effect such regulation would have on the operations and capital adequacy of the Registrant and its subsidiaries.\nPrior to December 31, 1992, each federal banking agency was required to review the accounting procedures it requires institutions it regulates to utilize in preparing reports or statements to be filed with such agency to ensure compliance with generally accepted accounting principles (\"GAAP\"). Additionally, certain accounting reforms require the federal banking agencies to implement regulations to require that \"off balance sheet\" assets and liabilities be taken into account in the preparation of a depository institution's financial statements. Furthermore, the federal banking agencies must develop a method for and require disclosure of the fair value of a depository institution's assets and liabilities in financial statements.\nCommencing in fiscal years after December 31, 1992, each depository institution must submit audited financial statements to its primary regulator and the FDIC, which reports will be publicly available. The audit committee of each institution must consist of outside directors and the audit committee at \"large institutions\" (as defined by FDIC regulation) must include members with banking or financial management expertise. The audit committee at \"large institutions\" must have access to independent outside counsel. In addition, an institution must notify the FDIC and the institution's primary regulator of any change in the institution's independent auditor, and annual management letters must be provided to the FDIC and the depository institution's primary regulator. The regulations define a \"large institution\" as one with over $500 million in assets. which would include the Company. Also, under the rule, an institution's independent auditor must examine the institution's internal controls over financial reporting and perform agreed-upon procedures to test compliance with laws and regulations concerning safety and soundness.\nIn 1993, federal banking agencies prescribed certain standards for depository institutions and their holding companies, including ratio of classified assets to capital, minimum earnings, compensation standards for officers, directors and employees and, to the extent feasible, a minimum ratio of market value to book value for publicly traded securities of such institutions and holding companies.\nThe Improvement Act authorizes the FDIC to issue obligations to and to borrow from BIF members in order to recapitalize the BIF. BIF members may only purchase obligations of or make loans to the FDIC to the extent of the bank's capital or retained earnings. In accounting for any investment in an obligation purchased from, or loan made to, the FDIC, the amount of such investment or loan will be treated by such bank as an asset.\nThe Improvement Act gives the FDIC authority to impose special assessments upon depository institutions to the extent necessary to repay the obligations of the FDIC. Any such assessment must be allocated between BIF members and SAIF members in amounts which reflect the degree to which proceeds borrowed are used for the benefit of the respective insurance funds.\nProvisions of the Improvement Act relax certain requirements for mergers and acquisitions among financial institutions, including authorization of mergers of insured institutions that are not members of the same insurance fund, and provide specific authorization for a federally chartered savings association or national bank to be acquired by any insured depository institution.\nUnder the Improvement Act, all depository institutions must provide 90 days notice to their primary federal regulator of branch closings, and penalties are imposed for false reports by financial institutions. Commencing in 1993, depository institutions with assets in excess of $100 million must be examined on-site annually by their primary federal or state regulator or the FDIC.\nThe Improvement Act also sets forth Truth in Savings disclosure and advertising requirements applicable to all depository institutions.\nProposed Legislation\nThe United States Senate and House Banking Committees have each passed, by strong margins, similar bills that would permit interstate ownership of banks by bank holding companies, and interstate branching by a single bank. If one of these bills is enacted, the effect would be to eliminate present federal and state law limitations on full interstate banking powers, over a phase-in period of eighteen months. States would be able to \"opt-out\" of the interstate banking provisions by enacting legislation to that effect. While many similar bills have been introduced in the past, the two pending bills appear to have greater support than previous bills. If one of the bills is enacted, the Registrant believes that industry costs will decrease as redundant operating structures are eliminated, but there will also be an increase in competition for banking customers, as well as an increase in consolidation of the banking industry. The Registrant is unable to predict whether any such legislation will be enacted, and what specific effect it might have on the Registrant.\nLegislation has been introduced in Congress, from time to time, that would repeal portions of the Glass Steagall Act, which forbids commercial banks from underwriting corporate securities and certain municipal securities. There is no active consideration by Congress of such proposed legislation at this time. In lieu of new legislation regarding the Glass Steagall Act, bank holding companies have received limited authority to underwrite and deal in certain securities through orders issued by the Federal Reserve Board. The Registrant is continuously evaluating whether it can and should avail itself of these limited approvals regarding securities powers. In this regard, the Registrant's various subsidiaries and divisions that engage in customer securities activities were restructured organizationally in the fourth quarter of 1988 to centralize control of all such activities (except for those under the direction of MAM and its subsidiaries) in anticipation of the possible expansion of securities trading and underwriting powers.\nCompetition\nMeridian Bank, Delaware Trust, and Meridian Bank, New Jersey compete with numerous other banking and financial institutions in their respective markets. Commercial banks, savings and loan associations and credit unions actively compete for savings and time deposits and for many types of loans. Such institutions, as well as an undetermined number of consumer finance companies, investment counseling firms, insurance companies, stock brokerage firms, money market funds, equipment leasing companies and corporate trustees, in addition to retailers of goods and services who offer consumer credit, may be considered major competitors of Meridian Bank, Delaware Trust and Meridian Bank, New Jersey with respect to one or more of the services they offer.\nPennsylvania law permits a Pennsylvania bank holding company (such as the Registrant) to expand by acquiring banks located in any state of the United States or the District of Columbia the laws of which allow such expansion. Also, bank holding companies located in another state are permitted by Pennsylvania law to acquire banks and bank holding companies in Pennsylvania, but only if the other state has enacted reciprocal legislation. \"Reciprocal\" legislation generally means legislation that permits Pennsylvania bank holding companies to acquire banks in such states and permits bank holding companies in those states to acquire Pennsylvania banks. In addition, pending legislation in the U.S. Congress to amend federal law to permit interstate bank ownership and branching appears to have such support. As a result, the Registrant expects the operating environment for Pennsylvania-based financial institutions to become increasingly competitive. Additionally, the manner in which banking institutions conduct their operations may change materially as the activities in which bank holding companies and their banking and nonbanking subsidiaries are permitted to engage increase, and funding and investment alternatives continue to broaden, although the long-range effects of these changes cannot be predicted, with reasonable certainty, at this time. These changes most probably will further narrow the differences and intensify competition between and among commercial banks, thrift institutions and other financial service companies.\nThe marketplace continues to see intense competition from financial institutions and nonbanks for deposits, credit and associated services. Further deregulation is expected to open up opportunities for new product offerings that will replace and complement existing product lines. The ability of the Registrant and its subsidiaries to remain competitive with such other financial institutions offering similar services will depend upon how successfully the Registrant can respond to the rapidly evolving competitive, regulatory, technological, and demographic developments which affect its operations.\nEmployees\nAs of December 31, 1993, the Registrant and its subsidiaries employed 6,917 persons on a full-time equivalent basis. The Registrant and its subsidiaries provide a full range of employment benefits and consider their relationships with their employees to be excellent.\nITEM 2.\n\n\nITEM 2. PROPERTIES\nAs of December 31, 1993, the Registrant, or a subsidiary of the Registrant, owned 201 properties in fee and leased 190. The properties owned in fee were at such date subject to liens, encumbrances or collateral assignments amounting in the aggregate to approximately $2.9 million.\nThe principal office of the Registrant and of Meridian Bank is owned in fee and is located at 35 North Sixth Street, Reading, Pennsylvania 19601. The principal office of Delaware Trust is leased and located at 900 Market Street Mall, Wilmington, Delaware 19899. The principal office of Meridian Bank, New Jersey is leased and is located at 176 Route 70, Medford, New Jersey 08055.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\nThe Registrant and certain of its subsidiaries are party (plaintiff or defendant) to a number of lawsuits. While any litigation has an element of uncertainty, management, after reviewing these actions with its legal counsel, is of the opinion that the liability, if any, resulting from all legal actions will not have a material effect on the consolidated financial condition or results of operations of the Registrant.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nCertain information, including principal occupation during the past five years, relating to each executive officer of the Registrant is set forth below:\nPrincipal Occupation Name Age For Last Five Years\nSamuel A. McCullough 55 Chairman and Chief Executive Officer, Registrant since February 1988; prior thereto, President and Chief Executive Officer, Registrant from June 1983; also, a Director of the Registrant and Chairman, Meridian Bank.\nEzekiel S. Ketchum 58 President, Registrant since February 1988 and Chief Operating Officer since December 1992; prior thereto, Vice Chairman, Registrant from September 1984; also, a Director of the Registrant and President and Chief Executive Officer, Meridian Bank.\nDavid E. Sparks 49 Vice Chairman and Chief Financial Officer, Registrant and Meridian Bank since February 1991; also a Director of the Registrant and Meridian Bank since 1993; prior thereto, Vice Chairman, Treasurer and Chief Financial Officer, Registrant and Meridian Bank from February 1990; prior thereto, Executive Vice President, Midlantic Corporation from 1985.\nRussell J. Kunkel 51 Vice Chairman, Registrant since February 1985; President and Chief Executive Officer, Meridian Mortgage Corporation since December 1992; also, Vice Chairman, Meridian Bank.\nJohn F. Porter, III 59 Chairman, President and Chief Executive Officer, Delaware Trust Company since July 1988; prior thereto, President, Delaware Trust Company.\nPaul W. McGloin 46 Executive Vice President, Registrant and Meridian Bank from July 1985.\nRobert J. Unruh 47 Chairman, Meridian Securities, Inc. since April 1990; also, Executive Vice President, Registrant and Meridian Bank from February 1985.\nJan S. Berninger 37 President, Lehigh Valley Division, Meridian Bank since December 1992; prior thereto, Executive Vice President, Corporate and Commercial Banking, Delaware Valley Division, Meridian Bank, June 1992 to December 1992; prior thereto, Senior Vice President, Meridian Bank from 1986.\nDavid R. Bright 55 President, Delaware Valley Division, Meridian Bank since February 1988; prior thereto, Executive Vice President, Berks/Schuylkill Division, Meridian Bank since 1987.\nThomas P. Dautrich 45 President, Susquehanna Valley Division, Meridian Bank since February, 1990; prior thereto, Executive Vice President, Registrant from December 1989; prior thereto, Senior Vice President, Registrant and Meridian Bank from 1986.\nGlenn E. Moyer 43 President, Berks/Schuylkill Division, Meridian Bank since February 1988; prior thereto, Senior Vice President, Delaware Valley Division, Meridian Bank (or its predecessor).\nAlice D. Flaherty 46 Executive Vice President, Registrant and Meridian Bank since December 1991; prior thereto, Senior Vice President, Registrant and Meridian Bank from 1985.\nWayne R. Huey, Jr. 49 Executive Vice President, Registrant and Meridian Bank since January 1988; prior thereto, President Lehigh Valley Division, Meridian Bank from April 1986.\nRichard E. Meyers 48 Executive Vice President, Registrant since 1983; also, Executive Vice President, Meridian Bank.\nGeorge W. Millward 44 Executive Vice President, Registrant since May 1992; prior thereto, managing associate, Coopers & Lybrand January 1987 to April 1992.\nChester Q. Mosteller 41 Executive Vice President, Registrant and Meridian Bank since December 1989; prior thereto, Senior Vice President, Registrant and Meridian Bank.\nP. Sue Perrotty 40 Executive Vice President, Registrant and Meridian Bank since July 1989; prior thereto, Senior Vice President, Registrant and Meridian Bank.\nThomas G. Strohm 44 Executive Vice President, Registrant since April 1991; prior thereto Senior Vice President, Registrant from 1986.\nPART II\nITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nShares of the Registrant's Common Stock are traded nationally in the over-the-counter market under the symbol MRDN and are quoted on the NASDAQ National Market System. As of February 15, 1994, the Registrant had 27,349 shareholders of record holding the Registrant's Common Stock.\nThe following sets forth the quarterly ranges of high and low bid prices, and the closing sale price, for shares of the Registrant's Common Stock for the periods indicated. Such prices represent quotations between dealers and do not include mark-ups, mark-downs or commissions, and may not necessarily represent actual transactions. The table also reflects cash dividends declared during the periods indicated.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nThe following sets forth certain selected historical consolidated financial data of Meridian for the periods indicated.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL HIGHLIGHTS\nMeridian Bancorp, Inc. (Meridian) reported record net income of $157.8 million in 1993 compared to $136.7 million in 1992, an increase of 15%. Earnings per fully diluted share were $2.74 in 1993 compared to $2.44 in 1992.\nThe returns on average assets and on average common shareholders' equity were 1.11% and 14.17%, respectively, in 1993 compared to 1.00% and 13.63%, respectively, in 1992.\nThe merger with Commonwealth Bancshares Corporation of Williamsport, Pa. (Commonwealth) was completed during the third quarter of 1993. Financial information for all prior periods presented has been restated to include the results of operations and financial position of Commonwealth.\nThe change in net income between 1993 and 1992 was primarily due to the following items:\n- An increase in net interest income of $44.1 million ($23.5 million after-tax).\n- A decrease in the provision for possible loan losses of $12.7 million ($9.0 million after-tax).\n- An after-tax loss of $33.7 million in the mortgage banking subsidiary.\n- Expenses of $11.9 million related to Meridian's merger with Commonwealth less securities gains of $8.3 million at Commonwealth, resulting in a reduction in pre-tax income of $3.6 million ($3.1 million after-tax).\n- An increase in other securities gains of $14.2 million ($9.2 million after-tax), and\n- Tax benefits of $7.2 million representing the cumulative effect on prior years of a change in the method of accounting for income taxes.\nNet interest income was $617.3 million in 1993 compared to $573.2 million in 1992, an increase of 8%. Widening spreads during the past twelve months between the yield on interest- earning assets and the cost of interest-bearing liabilities and a higher level of interest-earning assets resulted in a net interest margin on a taxable-equivalent basis of 4.96% in 1993 compared to 4.77% in 1992, an increase of 19 basis points.\nMeridian's provision for possible loan losses was $56.1 million in 1993, down from $68.8 million in 1992. The decline over the past year was due to continuing improvement in loan quality.\nNon-performing loans decreased for the eighth consecutive quarter to $127.6 million at December 31, 1993, or 1.42% of loans, from $143.6 million or 1.68% at the end of last year. The ratio of the allowance for possible loan losses to non-performing loans was 136% at December 31, 1993 compared to 115% a year ago.\nNet loans charged-off in 1993 were $51.3 million, or .59% of average loans, down from $84.6 million, or 1.00% of average loans, in 1992. The allowance for possible loan losses was 1.93% of total loans at December 31, 1993 compared to 1.94% a year ago.\nTotal non-performing assets also declined for the eighth consecutive quarter to $178.8 million at December 31, 1993, or 1.98% of loans and assets acquired in foreclosures, compared to $214.2 million or 2.48% at year-end 1992.\nThe loss in the mortgage banking subsidiary of $33.7 million ($.58 per fully diluted share) compared to a loss of $9.0 million in 1992 resulted primarily from several factors. A restructuring charge of $17.5 million in the third quarter of 1993 resulted from Meridian's decision to refocus its mortgage activities on the origination of residential mortgage loans and to substantially reduce the scope of its mortgage servicing business. Amortization of purchased mortgage servicing rights and other servicing-related assets increased by $11.6 million during 1993. The provision for possible credit losses on mortgage servicing portfolios purchased with recourse increased by $5.0 million compared to last year. Each of these changes is more fully explained in the \"Mortgage Banking\" portion of the \"Primary Business Activities\" section.\nNet income for the year also was impacted by expenses related to Meridian's merger with Commonwealth of $11.9 million less securities gains of $8.3 million at Commonwealth, resulting in a reduction in pre-tax income of $3.6 million ($3.1 million after-tax or $.05 per fully diluted share). Expenses include transaction costs, equipment and related asset write-offs, various contract terminations and severance. Commonwealth's balance sheet was restructured in accordance with Meridian's asset and liability strategy and a reserve was established for anticipated prepayment penalties on certain long-term borrowings. Securities gains resulted from the sale of mortgage-backed investments susceptible to prepayment risk in the current low interest rate environment.\nOther income was $285.3 million in 1993 compared to $242.9 million in 1992. Revenues in Meridian's broker-dealer and investment banking unit increased by $15.2 million or 28% between the two years. Service charges on deposits and fees for other customer services increased by $7.5 million, or 8%, over last year. Net securities gains, which include gains of $8.3 million related to Commonwealth, increased by $22.5 million between the two years, as more fully explained later.\nOther expenses were $636.9 million in 1993 compared to $561.9 million in 1992, an increase of 13%. Factors contributing to the increase include the mortgage banking restructuring charge and the increase in the provision for possible mortgage servicing-related credit losses which aggregated $22.5 million, one-time expenses of $11.9 million related to the Commonwealth merger, the continuing expansion of Meridian's broker-dealer and investment banking area, and increases in operating expenses in the banking unit partially as a result of several acquisitions during the year.\nTotal assets at December 31, 1993 were $14.1 billion compared to $14.3 billion at the end of 1992. Total loans were $9.0 billion compared to $8.6 billion a year ago, a 5% increase. The consumer portfolio increased by 13% between the two years and the commercial portfolio grew by 4%. This growth was partially offset by a decline in residential mortgage loans. Total deposits were $11.3 billion at December 31, 1993 compared to $11.8 billion a year ago, a 4% decrease. Meridian continues to fund a significant portion of its assets with deposits acquired in its local marketplace.\nShareholders' equity increased to $1.2 billion or 8.42% of total assets at December 31, 1993 compared to $1.1 billion or 7.41% a year ago. The ratio of tangible shareholders' equity to assets, which excludes $96.8 million of intangible assets, was 7.78% at December 31, 1993 compared to 6.44% at December 31, 1992. Meridian's risk-based capital ratio was 13.67% of total risk weighted assets at December 31, 1993, well above regulatory requirements. The ratio was 11.61% at December 31, 1992. Book value per common share was $20.39 at December 31, 1993 compared to $18.75 at December 31, 1992, an increase of 9%.\nPRIMARY BUSINESS ACTIVITIES\nTable 1 presents a summary of the operating results of Meridian's primary business activities. Capital is allocated primarily using regulatory risk-based capital guidelines. Staff support and product processing costs are allocated to the business units based on actual usage, with general costs supporting the entire corporation being retained by the parent company. Non-bank business units are allocated balance credits for deposit balances provided to the banking units.\nBanking. The banking unit provides a full range of retail and corporate banking services to customers in central and eastern Pennsylvania, as well as Delaware and southern New Jersey.\nNet income of the banking unit was $192.4 million in 1993 compared to $143.7 million in 1992, an increase of 34%. An increase in net interest income, higher levels of securities gains and a decrease in the provision for possible loan losses more than offset an increase of 5% in operating expenses.\nNet interest income on a taxable-equivalent basis increased 7% from $570.1 million in 1992 to $611.7 million in 1993. Widening spreads between the yields on interest-earning assets and the cost of interest-bearing liabilities and an increase in interest-earning assets produced a net interest margin on a taxable-equivalent basis of 4.77% in 1993 compared to 4.57% in 1992.\nLoans outstanding at December 31, 1993 were $9.4 billion compared to $9.2 billion at the end of 1992. Increases in the commercial and consumer loan portfolios more than offset a decrease in residential mortgage loans. Total deposits at December 31, 1993 were $11.3 billion compared to $11.7 billion a year ago, a 3% decrease. Changes in these categories are more fully explained in the \"Loans\" and \"Deposits\" sections.\nDuring 1993, Meridian completed the following four bank acquisitions:\nMortgage Banking. Meridian Mortgage Corporation originates financing for residential and multifamily properties, provides servicing for residential, commercial and multifamily mortgages, and purchases and sells servicing. New loan originations from both wholesale and retail operations aggregated $2.7 billion in 1993 compared to $2.9 billion in 1992.\nThe mortgage banking unit incurred a loss of $33.7 million in 1993 compared to a loss of $9.0 million in 1992. The increase in the loss from last year resulted primarily from:\n- A restructuring charge of $17.5 million, reflecting write-downs of $9.6 million to estimated fair value of mortgage servicing intangibles and other related assets and the establishment of reserves of $7.9 million associated with substantially reducing the scope of Meridian's mortgage servicing-related activities. Such reserves were established primarily for anticipated cash outflows related to various contract terminations, severance, and legal and other sale-related costs. As previously mentioned, Meridian decided in the third quarter of 1993 to refocus its mortgage activities on the origination of residential mortgage loans. Assets related to the sale of mortgage servicing aggregated $36.0 million at the end of 1993, almost unchanged from when the decision to sell such servicing was announced. It is currently expected that the sale will be completed in the first half of 1994.\n- An increase in amortization of $11.6 million for purchased mortgage servicing rights and other servicing-related assets.\n- An increase of $5.0 million in the provision for possible credit losses on mortgage servicing portfolios purchased with recourse.\nThe impact of these changes was partially lessened by higher gains on sales of loans and mortgage servicing, which were $19.3 million in 1993, an increase of $3.7 million from a year ago. Balance credits received by the mortgage banking unit were $6.0 million in 1993 compared to $7.4 million in 1992.\nThe increase in amortization for purchased mortgage servicing rights and other servicing-related assets resulted primarily from a significant increase in prepayments of mortgage loans that were being serviced, which reduced the value of these assets. The increase in prepayments resulted from the low level of long-term interest rates which has existed over the past year.\nThe increase in the provision for possible credit losses on mortgage servicing portfolios purchased with recourse resulted primarily from the continuing delinquencies in such portfolios and the financial difficulties, including bankruptcies, of the banks and thrifts in New England from which this servicing was purchased. Recourse servicing losses result principally from the inability of sellers to fulfill their obligations with respect to this servicing, repurchases of loans, indemnification and loss sharing payments, servicing advances, and costs of collection which are not reimbursed by third parties.\nMeridian is not currently experiencing any material credit losses on the remainder of the purchased recourse portfolios or from originated recourse servicing. At December 31, 1993, aggregate reserves with respect to recourse servicing (both purchased and originated) were $13.3 million compared to $7.0 million a year ago.\nThe mortgage portfolio serviced by Meridian Mortgage Corporation was $7.0 billion at December 31, 1993 compared to $9.7 billion at the end of 1992. The decline was caused primarily by mortgage loan refinancing activity and sales of mortgage servicing during 1993.\nAsset Management. Meridian Asset Management combines traditional bank trust services with investment and money management products and services for individuals, corporations and institutions.\nNet income from the asset management subsidiary was $2.4 million in 1993 compared to $3.8 million in 1992. Revenues increased by 7% between the two years. Contributing to the higher level of revenues were increases in personal trust fees and employee benefit and investment advisory fees. The increase in revenues was more than offset by an increase in operating expenses, such as personnel expense and professional fees, including payments to outside consultants for enhancements to operating systems. Balance credits received by the asset management unit were $1.3 million in 1993 compared to $1.5 million in 1992.\nThe market value of customers' assets administered by Meridian increased by 21% during the year from $22.7 billion at year-end 1992 to $27.5 billion at December 31, 1993. Included in these totals are assets for which Meridian has investment management responsibility of $6.1 billion at the end of 1993, an increase of 11% from last year. Asset growth in corporate trust, institutional accounts, and corporate services within the Delaware marketplace accounted for most of the increase in total assets in 1993.\nSecurities. Meridian Securities underwrites, brokers and distributes securities and loan servicing to institutional and individual investors. In addition, the company buys, sells and securitizes loans. The company also provides investment banking services by acting as financial advisors in facilitating municipal and corporate transactions in the capital market.\nThe securities unit experienced continued growth in 1993 with net income totaling $18.7 million compared to $15.6 million in 1992, an increase of 20%. Revenues increased by 27% in 1993, reflecting the continued expansion of the customer base and an increase in trading volume. The low interest rate environment prompted an increase in activity in mortgage related products, resulting in higher trading gains and commission income on the sale of securities and mortgage loans. Net interest income also increased between the two years, primarily because of higher levels of loans and investments related to the expanded activity of the securities unit.\nOperating expenses increased by 36% in 1993, mostly as a result of growth and expansion throughout the unit and increases in volume sensitive expenses such as commissions and other incentive-related compensation, and brokerage and clearance fees.\nParent Company and Other Units. Staff support expense and other corporate expenses not allocated by the parent company to the business units, net of taxes, were $22.1 million in 1993 compared to $17.4 million in 1992. Merger expenses related to Commonwealth and other acquisitions in 1993 of $11.5 million (after-tax $8.3 million) were the primary reason for the increase between the two years.\nNET INTEREST INCOME AND RELATED ASSETS AND LIABILITIES\nNet interest income is the single largest component of Meridian's operating income. Net interest income increased 8% to $617.3 million in 1993 from $573.2 million in 1992. For the same period, taxable- equivalent net interest income also increased 8% to $639.3 million from $594.0 million in 1992.\nThe level of net interest income results from the interaction among the volume and mix of interest-earning assets, the funding sources supporting these assets, and the interest rates earned on assets relative to those paid on the funding sources. The growth in net interest income in 1993 is attributable to a 3% increase in average interest-earning assets and to a 19 basis point improvement in the net interest margin from 4.77% in 1992 to 4.96% in 1993.\nAverage interest-earning assets increased to $12.9 billion in 1993 from $12.5 billion in 1992. The mix of earning assets remained almost unchanged. Loans accounted for 67% and 68% of average interest-earning assets in 1993 and 1992, respectively, while short and long-term investments accounted for 28% in each period.\nLoans accounted for approximately one-half of earning asset growth, increasing 3% to $8.7 billion from $8.4 billion in 1992. Average commercial loans increased by 1% in 1993. The lack of commercial loan growth is reflective of the continued weak loan demand within Meridian's marketplace throughout 1993. Average residential mortgage loans declined 14%, the result of accelerated prepayments of mortgages in the low interest rate environment that prevailed in 1993. Consumer loan growth was strong, with average outstandings increasing 16%. Most of this growth occurred in the home equity and indirect automobile loan categories, due to the low interest rate environment and enhanced marketing efforts.\nMeridian's securities portfolios accounted for the remainder of overall earning asset growth. Average securities and short- term investments increased 4% to $3.6 billion in 1993 from $3.4 billion in 1992. This growth resulted primarily from the investment of proceeds received from banking acquisitions and from Meridian Bank's issuance, in March 1993, of $150 million of 6 5/8% subordinated notes due in 2003.\nDeposit balances remained almost unchanged in 1993 compared to 1992, averaging $11.3 billion in both years. Meridian continued to experience a substantial shift in the mix of its deposit base, as customers elected to transfer proceeds from maturing time deposits into more liquid savings and interest- bearing transaction accounts. The combined average balances of savings, money market deposit and interest-bearing transaction accounts increased by $534 million in 1993, while short and long- term time deposits decreased by $548 million. Continued increases in demand deposit balances were offset by comparable declines in large dollar certificates of deposit. These deposit mix shifts can be attributed to the low interest rate environment.\nAverage short-term borrowings increased to $1.0 billion in 1993 from $853 million in 1992. Much of this increase was temporary and short-term borrowings declined to approximately $800 million by year-end 1993. Average balances of long-term debt increased from $241 million in 1992 to $439 million in 1993. Increases in this category primarily reflect proceeds from Meridian Bank's issuance of subordinated debt during 1993.\nThe net interest margin is affected by both the net interest spread and the level of non-interest bearing sources of funds. The net interest spread increased by 27 basis points between the two years. This increase can be attributed to the substantial shift in Meridian's funding mix from higher costing time deposits into lower costing savings and interest-bearing transaction accounts, the wide spread earned on national commercial rate-based loans relative to their short-term funding costs, and the favorable yield curve that prevailed throughout the year. Average yields on loans declined by 62 basis points between 1992 and 1993, while rates paid on interest-bearing liabilities declined by 96 basis points.\nThe amount of interest income not recognized on non- performing loans was reduced from $13.1 million in 1992 to $9.5 million in 1993. The negative impact on the net interest spread of carrying non-performing loans was 7 basis points in 1993 and 11 basis points in 1992.\nInterest free funding sources increased 14% to $1.8 billion in 1993. However, the beneficial effect of growth in interest- free funding on overall funding costs was not sufficient to offset the reduced value of these funds in the low interest rate environment. The overall effect of these changes in non-interest bearing funds reduced the net interest margin by 8 basis points in 1993 compared to 1992.\nMeridian's profitability has benefitted from the favorable interest rate environment that existed during the past several years. The spread between the national commercial rate, which affects variable-rate loan products, and the federal funds rate, which affects the cost of deposits and borrowings, continues to be wider than in prior periods. Management cannot predict whether market conditions will continue to provide similar opportunities, and currently anticipates future contraction in the net interest margin. However, management believes that the negative impact of declining spreads should be mitigated by anticipated improvement in economic activity and the resultant anticipated increase in loan demand.\nInterest Rate Risk Management. The absolute level and volatility of interest rates can have a significant impact on Meridian's profitability. The objective of interest rate risk management is to identify and manage the sensitivity of net interest income to changing interest rates and other financial market factors, in order to achieve overall financial goals. Based on economic conditions, on and off-balance sheet positions, asset quality and various other considerations, management establishes tolerance ranges for interest rate sensitivity and manages within these ranges.\nMeridian generates a mix of loans and deposits that tends to create an asset sensitive interest rate risk profile primarily because Meridian's retail core deposit base does not reprice as quickly as the loan portfolios. An asset sensitive profile indicates that net interest income would be positively impacted in periods of rising interest rates and negatively impacted in periods of declining interest rates. Meridian manages this tendency towards asset sensitivity by adjusting the mix and repricing characteristics of assets and liabilities on the balance sheet through its securities and purchased funding portfolios and by the use of off-balance sheet derivative products, mainly interest rate swaps. The notional amount of interest rate swap contracts, which include forward interest rate swaps of $150 million, was $2.3 billion at December 31, 1993 compared to $2.2 billion a year ago.\nMeridian uses interest rate swaps as a tool to alter the repricing characteristics of a portion of the core deposit base. Interest expense on deposits was reduced by approximately $43 million in 1993 and $45 million in 1992 as a result of interest rate swaps.\nThe majority of the interest rate swap contracts outstanding at December 31, 1993, or approximately $2.1 billion, represents contracts on which Meridian receives a fixed rate of interest and pays a variable rate, thereby favorably impacting net interest income in periods of declining interest rates. The average fixed rate received at the end of 1993 was 4.95% with a remaining term of approximately 1.6 years. Forward interest rate swaps of $150 million, with a fixed rate of 4.84% and a term of approximately 1.7 years, were entered into in late 1993 to replace maturities of swaps in 1994. The average floating rate paid on interest rate swaps is based on short-term variable rates such as LIBOR (London Interbank Offered Rate). The average floating rate paid was 3.39% at December 31, 1993.\nThe favorable impact of Meridian's interest rate swaps on net interest income will decrease in a rising interest rate environment. This change should be mitigated by the anticipated growth in net interest income mainly because of the anticipated expansion of Meridian's banking business.\nDuring 1993, new swap contracts entered into aggregated $1.6 billion and maturities and terminations of contracts aggregated $1.5 billion. Deferred gains resulting from the termination of swap contracts were $2.0 million at the end of 1993 and will be accreted into income over approximately the next two years.\nInterest rate swaps involve credit risk as a result of Meridian's reliance on counterparties to make payments over the life of the contracts. The credit risk is limited to the estimated aggregate replacement cost of those agreements in a gain position (favorably impacting net interest income) and amounted to approximately $5 million at December 31, 1993. Meridian has credit policies and procedures addressing counterparty exposures and operates within established credit limits.\nMeridian uses income simulation modeling as the primary tool in measuring interest rate risk. Simulation modeling considers not only the impact of changing interest rates on future net interest income, but also other potential causes of variability such as earning-asset volume and mix, yield curve relationships, loan spreads, customer preferences and general market conditions.\nA managerial gap analysis is used to supplement simulation modeling. The traditional gap analysis considers the contractual maturity and repricing characteristics of all assets, liabilities and off-balance sheet positions and identifies mismatches between these positions at various time intervals.\nThis traditional analysis indicates a large liability sensitive position through the one-year time period beginning December 31, 1993. However, it does not accurately reflect Meridian's interest rate sensitivity, as previously discussed. Meridian's net interest income has not been subject to the degree of sensitivity indicated by this traditional gap analysis because the analysis does not reflect the fact that the rates on Meridian's core deposits do not reprice as quickly as market rates. Consequently, adjustments are made to this analysis to reflect management's experience and assumptions regarding the impact of product pricing, interest rate spread relationships and customer behavior.\nThese managerial adjustments are necessarily subjective and will vary over time with loan and deposit changes, customer preferences and market conditions. However, management believes the managerial adjusted gap analysis provides a more realistic picture of the interest rate risk characteristics of Meridian's balance sheet.\nThe managerial adjusted gap position at December 31, 1993, as provided in Table 4, indicates a moderate liability sensitive position through the one-year time period.\nLiquidity. The objective of liquidity management is to ensure that sufficient funding is available, at reasonable cost, to meet the ongoing and potential cash needs of Meridian and to take advantage of income producing opportunities as they arise. While the desired level of liquidity may vary depending upon a variety of factors, it is a primary goal of Meridian to maintain a high level of liquidity in all economic environments.\nManagement considers Meridian's liquidity position at the end of 1993 to be sufficient to meet its foreseeable cash flow requirements.\nLiquidity management is influenced by several key elements, including Meridian's reputation, asset quality, the maturity structure of its assets and liabilities, cash flow generated by assets, and Meridian's ability to access funds in the capital markets. The single most important source of liquidity for Meridian is its core deposit base, which consists of deposits from customers with long-standing relationships. Meridian continues to promote the acquisition of core deposits through the capabilities of its retail distribution systems and through selective banking acquisitions. Long-term debt and shareholders' equity also contribute to liquidity by reducing the need for short-term funding. In 1993, Meridian funded approximately 80% of total assets with deposits acquired within its local marketplace and approximately 90% of total assets with core deposits, long-term debt and shareholders' equity.\nMeridian places strong emphasis on the maintenance of an appropriate level of asset liquidity. Liquid assets include short-term money market investments, securities available for sale, and interest-bearing deposits with other banks. Cash flow from mortgage and asset-backed securities also provide a significant source of liquidity.\nMeridian is committed to maintaining additional funding flexibility through access to the debt and capital markets. Meridian Bank, Meridian's principal banking subsidiary, has access to a variety of money market sources of funds, such as Federal funds purchased and securities sold under agreements to repurchase, as well as to term funding through the potential issuance of bank notes, bank deposit notes and subordinated debt. Additionally, Meridian has the capacity to issue securities under its shelf registration filed with the Securities and Exchange Commission. In January, 1993, Meridian increased the availability under its shelf registration by $150 million. As of December 31, 1993, Meridian had debt and preferred equity securities registered but unissued under this registration totalling $250 million.\nThe cost and availability of external funding is influenced by Meridian's credit ratings. The following is a summary of Meridian's and Meridian Bank's ratings at December 31, 1993, as issued by various credit rating agencies:\nReference should also be made to the Statements of Cash Flows appearing in the Consolidated Financial Statements for additional information on liquidity. The statement of cash flows for 1993 reflects $376.2 million of cash provided by operations, $50.5 million used by investing activities and $459.4 million used by funding activities. Operating activities include $157.8 million in net income for 1993. Investing activities are primarily comprised of both proceeds from and purchases of short- term investments, investment securities, investment securities available for sale and loans. Financing activities present the net change in Meridian's various deposit accounts and short-term borrowings, and also include $197.6 million in net proceeds from the issuance of long-term debt in 1993. Cash flows from operations and the issuance of long-term debt were used to fund the decreases in deposits and short-term borrowings during 1993.\nLoans. The lending function is Meridian's principal business activity and it is Meridian's continuing policy to serve the credit needs of its customer base. The economy in Meridian's primary marketplace is broad-based and diverse and the loan portfolio reflects that diversity. Lending to individual consumers in this marketplace accounts for approximately one- third of total loans. The remainder of the portfolio consists predominantly of commercial loans and commercial real estate loans in Meridian's primary marketplace.\nLoans were $9.0 billion at December 31, 1993 compared to $8.6 billion at December 31, 1992, an increase of 5%. Increases in the commercial and consumer loan portfolios more than offset a decrease in residential mortgage loans.\nCommercial loans amounted to $5.4 billion at December 31, 1993 compared to $5.2 billion at December 31, 1992, a 4% increase. Meridian's commercial loan portfolio is oriented toward diversified, small and medium-sized businesses within Meridian's market area, with limits on the size of loans to any single borrower according to credit risk. These loans are predominantly in the services, real estate, and manufacturing industries. Credit risk associated with these borrowers is principally influenced by general economic conditions and the resulting impact on the borrower's operations. Geographical coverage of Meridian's commercial lending activity extends across central and eastern Pennsylvania, southern New Jersey and Delaware.\nReal estate-related commercial loans, including real estate construction and commercial mortgages, totalled $1.9 billion and represented 21% of total loans at December 31, 1993 compared to $1.9 billion and 22% at December 31, 1992. Construction loans decreased by $24.4 million or 9% from year-end 1992 and partially offset a slight increase in commercial mortgages.\nThe construction and commercial mortgage real estate portfolios are located primarily in markets in which Meridian has a local banking presence. Collateral types are diverse and include the real estate of borrowers who utilize the property in their businesses as well as real estate investors. At December 31, 1993, real estate investor outstandings comprised 12% of total loan outstandings compared to 13% at December 31, 1992. Construction loans comprised 3% of total loan outstandings at December 31, 1993, unchanged from the end of 1992.\nCommercial, financial and agricultural loans totalled $3.6 billion and represented 40% of total loans at December 31, 1993 compared to $3.4 billion and 40% at the end of 1992.\nConsumer lending includes primarily loans to individuals in communities served by Meridian. These loans include open-ended credit arrangements, such as home equity loans, and closed-end loans subject to specific contractual payment schedules, such as installment loans and residential mortgages.\nResidential mortgage loans decreased from $1,057.6 million at December 31, 1992 to $993.5 million at December 31, 1993. This change resulted primarily from mortgage refinancing activity in the low interest rate environment during the past year. Management remains committed to serving the residential mortgage market through both the retail branches of Meridian's commercial banks and its mortgage banking subsidiary.\nConsumer loans, which consist of loans made to individuals on an installment or revolving credit basis, totalled $2.5 billion at December 31, 1993 compared to $2.2 billion at December 31, 1992, an increase of 13%. The increase in consumer loans during 1993, mostly home equity loans and other types of personal loans, resulted primarily from enhanced marketing efforts in the relatively low interest rate environment during the year.\nInvestment Securities and Investment Securities Available for Sale. The classification of securities is determined at the time of purchase. Securities are classified as investments and carried at amortized cost if management has the intent and ability to hold the securities until maturity.\nThe carrying value of the investment portfolio at December 31, 1993 was $2.8 billion and net unrealized gains totalled $28.6 million. Such gains include gross unrealized gains of $35.7 million and gross unrealized losses of $7.1 million. At the end of 1992, the carrying value of the investment portfolio was $2.5 billion and net unrealized gains totalled $44.6 million. The average maturity of the investment portfolio at December 31, 1993 was 2.8 years compared to 2.5 years at December 31, 1992.\nSecurities expected to be held for an indefinite period of time are classified as investment securities available for sale and are carried at the lower of aggregate amortized cost or fair value. Decisions to purchase or sell these securities are based on an assessment of economic and financial conditions, including changes in interest rates and prepayment risks, liquidity and capital needs, alternative asset and liability management strategies, regulatory requirements and tax considerations. The carrying value of this portfolio at December 31, 1993 was $275.7 million, with net unrealized gains of $12.5 million. Such gains include gross unrealized gains of $12.7 million and gross unrealized losses of $203 thousand. The carrying value of this portfolio and net unrealized gains at year-end 1992 were $945.2 million and $28.2 million, respectively. The average maturity of the investment securities available for sale portfolio, which includes tax-exempt obligations of states and municipalities, was 5.5 years at December 31, 1993 compared to 5.9 years at December 31, 1992.\nThe significant decline in investment securities available for sale is attributable to a restructuring of Commonwealth's balance sheet in accordance with Meridian's asset and liability strategy. Securities gains of $8.3 million resulted from the sale of mortgage-backed investments susceptible to prepayment risk in the current low interest rate environment. Additionally, in the first quarter of 1993, Meridian sold $217 million of U.S. Treasury and federal agency securities with maturities of less than one year, recognizing gains of $5.5 million.\nMeridian's securities portfolios (investment securities and investment securities available for sale) are comprised of U.S. Treasury and federal agency securities, mortgage-backed securities, tax-exempt obligations of states and municipalities, corporate securities, including privately issued asset-backed securities, and equity securities.\nU.S. Treasury and federal agency securities (other than mortgage-backed securities) totalled $733 million at year-end 1993 and accounted for approximately 24% of total securities holdings.\nMortgage-backed securities remain the largest component of Meridian's securities portfolios, accounting for approximately 55% of the total at year-end 1993. This portfolio is comprised of federal agency mortgage-backed securities and other collateralized mortgage obligations which are backed by federal agency collateral or are AAA rated private issues. Because of the intent to hold a majority of these securities to maturity, management evaluates and closely monitors cash flow projections for all mortgage-backed securities. Investment strategy over the past several years has focused primarily on the purchase of mortgage-backed securities which have generally predictable cash flows. The expected average life of mortgage-backed securities at December 31, 1993, based on projected prepayment rates, was 2.2 years compared to 2.5 years at year-end 1992.\nMeridian's current credit guidelines call for purchases of securities issued by either the U.S. Treasury or federal agencies, or by states and municipalities or corporate entities that are rated A or higher by Moody's Investor Services, Inc. or Standard and Poor's Corporation. At December 31, 1993, the carrying value of state and municipal securities was $410 million, 90% of which was rated A or higher by the rating agencies. Securities rated Baa and below totalled $1.6 million and $40.9 million were non-rated. In the first quarter of 1994, $30.5 million of the non-rated securities were called, reducing the balance to $10.4 million. Generally, non-rated securities are collateralized by letters of credit or are securities in which the principal and interest is supported by government obligations set aside in escrow accounts. At December 31, 1993, the carrying value of corporate securities, excluding AAA rated private mortgage-backed and asset-backed securities, was $11.5 million. Corporate securities rated Baa and below totalled $5.2 million and $3.8 million of such securities were non-rated.\nTax-exempt obligations of state and municipalities comprised 13% of the securities portfolios at year-end 1993 compared to 15% at year-end 1992. The decline is attributable to maturities and calls of higher-yielding securities in the low interest-rate environment. Management continues to purchase qualified tax- exempt securities.\nEffective in the first quarter 1994, Meridian will adopt Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" which requires investments in equity securities with a readily determinable fair value and investments in all debt securities to be classified in one of three categories. The three categories are (1) held to maturity -- carried at amortized cost; (2) available for sale -- carried at fair value (with unrealized gains and losses, net of related tax effect, recorded as a separate component of shareholders' equity); and (3) trading account - carried at fair value (with unrealized gains and losses recorded in the income statement). The impact of this accounting change, had Meridian elected to adopt this statement at December 31, 1993, would have been to increase shareholders' equity by approximately $8.1 million or less than 1%, representing the after-tax unrealized gain in the available for sale portfolio.\nDeposits. Total deposits were $11.3 billion at December 31, 1993 compared to $11.8 billion at year-end 1992, a decrease of 4%. Approximately 60% of the decline occurred in time deposit categories and resulted from anticipated runoff of deposits from recent acquisitions. The lower interest rates on deposits also resulted in depositors seeking alternative investment opportunities. The remaining 40% of the decline is attributable to a planned reduction in certificates of deposit of $100,000 and more.\nShort-Term Borrowings. At December 31, 1993, short-term borrowings, comprised of Federal funds purchased, securities sold under agreements to repurchase, and Federal Home Loan Bank and other borrowings totalled $791.7 million compared to $877.1 million a year earlier, a 10% decrease.\nLong-Term Debt and Other Borrowings. This category amounted to $421.3 million at December 31, 1993 compared to $313.8 million at December 31, 1992, an increase of 34%. Subordinated debt of $321.6 million is included in this category, along with capitalized lease obligations, longer-term borrowings from the Federal Home Loan Bank, and various other loans and mortgages payable. The increase is attributable to Meridian Bank's issuance, in March 1993, of $150 million of 6 5/8% subordinated notes due in 2003. Proceeds were used by Meridian Bank to retire $60 million of subordinated notes issued to Meridian and $7 million of outstanding subordinated notes issued to the public. The remaining net proceeds were used for general corporate purposes.\nReference should be made to Note 6 of the Notes to Consolidated Financial Statements for an additional analysis of short-term borrowings and long-term debt.\nPROVISION FOR POSSIBLE LOAN LOSSES AND RELATED CREDIT QUALITY\nMeridian manages asset quality and controls credit risk through diversification of the loan portfolio and the application of policies designed to foster sound underwriting and loan monitoring practices. Meridian's loan administration function is charged with monitoring asset quality, establishing credit policies and procedures, and enforcing the consistent application of these policies and procedures across Meridian.\nCommercial loans are assigned risk ratings by loan officers. The appropriateness of these ratings, in addition to the overall lending process, is reviewed by credit policy personnel. A quarterly review and reporting process is in place for monitoring those loans that have been identified as problems or potential problems. A separate loan workout department is involved with the collection of problem loans. Because of their relatively homogeneous nature and small dollar size, consumer and residential mortgage loans are generally reviewed in the aggregate.\nWhen establishing the appropriate levels for the provision and the allowance for possible loan losses, management performs an analysis of the loan portfolio by considering a variety of factors. This analysis includes periodic reviews by loan review and loan workout personnel of all borrowers with aggregate balances of $250,000 or greater. Meridian also reviews, at least on a quarterly basis, problem borrowers with balances of $500,000 or greater, as well as selected lower balance loans. Consideration is given to the impact of current and anticipated economic conditions, the diversification of the loan portfolio, historical loss experience, delinquency statistics, reviews performed by loan officers who are primarily responsible for compliance with established lending policy, the perceived financial strength of borrowers, and the perceived adequacy of underlying collateral. Consideration is also given to examinations performed by regulatory authorities. Lending procedures and the loan portfolio are examined periodically by several banking regulatory agencies as part of their supervisory activities. For Meridian, the most comprehensive of these examinations is performed by the Federal Reserve Bank.\nTo assist in determining the adequacy of the provision and the allowance, management first sets the allocated portion of the allowance for possible loan losses. For commercial loans, allocations of the allowance to individual loans are based on borrower specific data determined by reviewing individual non- performing, delinquent, problem, and other loans and by considering those items described in the preceding paragraph. In addition, general allocations of the allowance are made to the commercial loan category. General allocations to commercial loans also consider the impact of current and anticipated economic conditions on both individual borrowers and the commercial loan portfolio taken as a whole. Consumer and residential mortgage loan allocations are determined in the aggregate and are based on recent chargeoff history and delinquency trends, anticipated losses over the foreseeable future, and the impact of current and anticipated economic conditions in the local, regional and national economies. The unallocated portion of the allowance is that amount, which when added to the allocated allowance, brings the total allowance to the amount deemed adequate by management at the time. Management considers the unallocated portion of the allowance, which is determined by reviewing those items described in the preceding paragraph, as a subset of the entire allowance and, consequently, available to absorb losses anywhere within the loan portfolio.\nThe loan portfolio represents loans made primarily in Meridian's market area in eastern and central Pennsylvania and in Delaware and southern New Jersey. Management continues to monitor the economic conditions in this market area. The ultimate collectibility of a substantial portion of Meridian's loans, especially its real estate loans, and the market value of other real estate owned, is susceptible to changes in economic conditions in this primary market area, as was especially evident over the past several years.\nDetermining the level of the allowance for possible loan losses at any given date is difficult, particularly in a continually changing economy. Management must make estimates, using assumptions and information which are often subjective and changing. Management continues to review Meridian's loan portfolio in light of a changing economy and possible future changes in the banking and regulatory environment. Although the economy continues to improve slowly, the balance in the allowance at December 31, 1993 reflects Meridian's continuing concerns about the strength and the duration of the current economic recovery, especially in the commercial and construction real estate sectors of the economy, in the geographic markets served by Meridian. In management's opinion, the allowance for possible loan losses is adequate at December 31, 1993.\nThe balance in the allowance for possible loan losses was $173.4 million or 1.93% of total loans at the end of 1993 compared to $165.5 million or 1.94% of total loans at the end of 1992. Although there was an overall improvement in loan quality in 1993, as evidenced by a decline in non-performing loans, the relatively high level in the allowance reflects management's continuing concerns about the strength and the duration of the current economic recovery.\nThe provision for possible loan losses represents charges made to earnings to maintain an adequate allowance for possible loan losses. The provision for possible loan losses was $56.1 million in 1993 compared to $68.8 million in 1992. The decline of $12.7 million resulted primarily from the continuing improvement in loan quality. The overall improvement in asset quality was also evident in a decrease of $12.4 million in writedowns and other expenses associated with foreclosed real estate, from $23.3 million in 1992 to $10.9 million in 1993.\nNet charge-offs were $51.3 million or .59% of average loans in 1993 compared to $84.6 million or 1.00% of average loans in 1992. Recoveries were $11.2 million in 1993 compared to $10.6 million in 1992. The impact of the recent recession has made it increasingly more difficult to realize significant recoveries of previously charged-off loans, especially in the real estate area.\nTable 13 presents a summary of various indicators of credit quality. At December 31, 1993, non-performing assets as a percentage of period-end loans and assets acquired in foreclosures were 1.98% compared to 2.48% at the end of last year. Non-performing assets were $178.8 million at December 31, 1993 and decreased by $35.4 million during the past year from $214.2 million a year ago. This decrease resulted from an overall improvement in asset quality during the year and an increase in payments received, combined with continuing high levels of loan chargeoffs and writedowns of other real estate. Real estate-related non-performing assets were 65% of total non- performing assets at December 31, 1993.\nNon-performing loans were 1.42% of total loans at December 31, 1993 compared to 1.68% at the end of last year. Non- performing loans amounted to $127.6 million at December 31, 1993 and decreased by $16.0 million during the past year from $143.6 million a year ago. Non-performing assets and loans past due 90 or more days as to interest or principal at December 31, 1993 were $203.6 million or 2.25% of loans and assets acquired in foreclosures compared to $255.3 million or 2.96% one year ago, a decrease of $51.7 million.\nThe ratio of the allowance for possible loan losses to non- performing loans was 136% at December 31, 1993 compared to 115% at year -end 1992. The coverage of non-performing assets was 97% at year-end 1993 compared to 77% at December 31, 1992. It should be noted that any possible future losses on foreclosed real estate and in-substance foreclosures which are included in non- performing assets are charged directly to earnings and not to the allowance for possible loan losses. Foreclosed real estate is carried at the lower of cost or fair value, less estimated costs of disposal.\nNon-performing assets are comprised of non-accrual loans, loans categorized as troubled debt restructurings, and assets acquired in foreclosures which includes in-substance foreclosures. Non-performing assets do not include loans past due 90 days or more as to interest or principal which are well secured and in the process of collection, the majority of which represent residential mortgage loans.\nGenerally, a commercial loan is classified as non-accrual when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for 90 days or more, unless such loan is well secured and in the process of collection. When the accrual of interest is discontinued, unpaid interest is reversed through a charge to interest income. The majority of non-accrual loans are secured by various forms of collateral, the ultimate recoverability of which is, however, subject to economic conditions and other factors.\nResidential mortgages which are 180 days or more delinquent are placed on nonaccrual status when total principal, interest, and escrow owed exceeds 80% of the property's appraised value. Properties are re-appraised when foreclosure proceedings are initiated.\nNon-accrual loans totalled $124.3 million at December 31, 1993 compared to $142.7 million one year ago, a decrease of $18.4 million or 13%. The carrying value of non-accrual commercial loans at December 31, 1993 has already been reduced by charge- offs and payments to 57% of the aggregate carrying value when such loans were originally placed into a non-performing status. Payments of $19.1 million were received on these loans in 1993, almost all of which was applied as a reduction in the principal outstanding. Meridian's non-accrual loans include only six loans with balances in excess of $2.5 million (only one of which is over $5 million), indicating that a substantial portion of the risk is spread across a significant number of borrowers. These six loans aggregated $25.0 million or approximately one-fifth of total non-accrual loans at December 31, 1993. Table 15 classifies non-accrual loans according to various levels of payment performance.\nA loan is categorized as a troubled debt restructuring if the original interest rate on the loan, repayment terms, or both, were restructured on a below market basis due to a deterioration in the financial condition of the borrower. If restructured loans are not performing according to revised terms, such amounts are included in non-accrual loans.\nThe level of assets acquired in foreclosures (except consumer related), including in-substance foreclosures, was $50.0 million at December 31, 1993 compared to $68.3 million a year ago. A loan is classified as an in-substance foreclosure when the borrower is perceived to have little or no equity in the project, the borrower appears to be unable or unwilling to rebuild equity or repay the loan in the foreseeable future, and the bank can reasonably anticipate proceeds for repayment only from the operation or sale of the collateral. These assets are carried at the lower of cost or fair value, less estimated selling expenses.\nAssets acquired in foreclosures at December 31, 1993 have already been reduced by charge-offs and payments to 43% of the aggregate carrying value when such assets were originally placed into non-performing status. Assets acquired in foreclosures include only three properties with balances in excess of $2.5 million (one of which is over $5 million) at year-end 1993, aggregating $16.1 million or approximately one-third of the total of such assets. At present, the marketability of Meridian's foreclosed real estate remains somewhat limited principally because of general illiquidity in the commercial real estate market. If real estate values decline further, additional writedowns of the current portfolio may be necessary and foreclosures may increase.\nReference should be made to Table 5 for a summary of the period-end balances in the loan portfolio. There has not been a significant change in the percentage of each category to total loans from a year ago except for those changes caused by the decline in residential mortgage loans and the increase in other consumer loans, as previously discussed.\nIn addition, reference should be made to Table 16 for a breakdown of commercial loans by major industry and to Table 17 for a breakdown of commercial real estate loans by category. As can be seen in these tables, Meridian's portfolio of commercial loans and commercial real estate loans is diversified and covers a wide range of borrowers. This diversification generally characterizes the economy of Meridian's primary market area. Of Meridian's commercial real estate loans, almost all, or 99%, are to borrowers for property in Pennsylvania, Delaware, and New Jersey, of which Pennsylvania has 81%, or the largest single share. In connection with the decision to extend credit to particular borrowers, Meridian takes into account, among other things, asset diversification and particular risks presented by the different industries in which such borrowers compete, in light of changing economic circumstances.\nLoan concentrations are considered to exist when a multiple number of borrowers are engaged in similar activities and have similar economic characteristics which would cause their ability to meet contractual obligations to be similarly impacted by economic or other conditions. At December 31, 1993, Meridian's commercial loans and commitments did not have any industry concentration or other known concentration that exceeded 10% of total loans and commitments. However, the effect of the recent recession has had a negative impact on the financial performance of many companies involved in retail trade. At December 31, 1993 Meridian's loans to companies in retail trade totalled $721.6 million, or 8% of total loans outstanding and 13% of total commercial loans outstanding. Included in this total were loans to department stores and other retailers of $358.9 million and loans to automobile dealers of $362.7 million. Loans to companies in retail trade included $16.9 million of loans in a non-accrual status at December 31, 1993, representing 13% and 18% of non-performing loans and non-performing commercial loans, respectively, at that date. Meridian has no foreign loan exposure.\nA leveraged buyout generally produces a new company with a large amount of debt relative to equity. Such debt is usually secured primarily by the assets of the acquired company. If interest rates rise or if economic conditions deteriorate, a highly leveraged company may have difficulty servicing its debt obligation.\nMeridian's policy has been to participate selectively in large, public, highly leveraged transactions. The majority of such transactions is currently in the telecommunications industry and its cable television and cellular phone segments. According to the guidelines issued by the Federal Reserve Board, loans and exposures are characterized as highly leveraged transactions if they meet certain defined leverage criteria and the total financing package (including all obligations held by all participants) originally exceeded $20 million. At December 31, 1993, Meridian's highly leveraged transactions aggregated $67.3 million in outstanding balances or less than 1% of total loans, and an additional $27.7 million in commitments. All such balances were current as to principal and interest at the end of 1993. Cable television and cellular phone exposures represented $49.6 million of such loans outstanding and $14.5 million of the commitments outstanding.\nPotential problem loans consist of loans which are included in performing loans at December 31, 1993, but for which potential credit problems of the borrowers have caused management to have concerns as to the ability of such borrowers to comply with present repayment terms. At December 31, 1993, such potential problem loans, not included in Table 13, amounted to approximately $31 million compared to approximately $34 million one year ago. No loans to companies in retail trade were included in potential problem loans at December 31, 1993. Depending on the state of the economy and the impact thereof on Meridian's borrowers, as well as other future events, these loans and others not currently so identified could be classified as non-performing assets in the future.\nOTHER INCOME\nMeridian's businesses generate various sources of other income, such as trust revenues, mortgage banking fee income and gains on sales of mortgage loans and mortgage servicing, broker- dealer and investment banking revenues, securities gains, service charges on deposit accounts, and other service charges, commissions and fees.\nOther income was $285.3 million in 1993 compared to $242.9 million in 1992, an increase of 17%.\nTrust revenues were $41.7 million in 1993 compared to $38.5 million in 1992, an increase of 8%. Contributing to the higher level of revenues were increases in personnel trust, employee benefit and investment advisory fees.\nMortgage banking revenues were $36.0 million in 1993 compared to $47.7 million in 1992. Net servicing revenues decreased by $15.5 million between the two years, mainly because of an increase in amortization of $11.6 million for purchased mortgage servicing rights and other servicing-related assets. This amount is recorded as a reduction of mortgage banking revenues. Servicing revenues also decreased due to the lower level of mortgage loans being serviced because of loan payoffs in the declining interest rate environment and sales of servicing. The negative impact of the decline in net servicing revenues was partially offset by higher gains on sales of loans and mortgage servicing, which were $19.3 million in 1993, an increase of $3.7 million from a year ago.\nIn addition to the changes in mortgage banking revenues described previously, earnings in the mortgage banking unit were affected by a $17.5 million restructuring charge, mentioned previously, which is classified as an other operating expense.\nBroker-dealer and investment banking revenues totalled $69.4 million in 1993 compared to $54.2 million in 1992, an increase of 28%. The increase in revenues is due to the continued growth within the securities unit. This growth is reflected in the increase in net trading gains resulting from higher levels of sales of securities and mortgage loans. Net tender option bond fees increased from the prior year, primarily due to the decline in interest rates during 1993. Commissions and fees increased from last year due to the growth in retail brokerage activity. Because of the continued high level of mortgage loan refinancing activity during the past two years, revenues were reduced by charges related to reserves against certain investments in collateralized mortgage obligation residuals. The impact of these reserves was lessened by gains from the sales of various other investments in both years.\nService charges on deposits increased by 10% between the two years, from $49.0 million in 1992 to $53.8 million in 1993. Increases in certain fees for deposit products, as well as additional deposit accounts because of bank acquisitions over the past year, contributed to the higher level of service charges.\nNet securities gains were $25.3 million in 1993 compared to $2.8 million in 1992. The amount in 1993 included gains of $25.5 million and losses of $203 thousand. These gains are in addition to gains of $2.0 million from sales primarily of mortgage-related investments, which are included in broker-dealer and investment banking revenues. Included in the total for 1993 is a gain of $8.6 million on the sale of Meridian's common stock investment in Fidelity National Financial, Inc. This stock was acquired as part of the sale of Meridian's title insurance operations in 1992. A gain of $5.5 million was recognized from the sale of investment securities available for sale in the first quarter of 1993, mainly U.S. Treasury and federal agency securities with maturities of less than one year. Finally, a gain of $8.3 million was recognized from the sale of some of Commonwealth's mortgage-backed investments which are susceptible to prepayment risk in the current low interest rate environment.\nOTHER EXPENSES\nOther expenses were $636.9 million in 1993 compared to $561.9 million in 1992. The increase resulted primarily from the following factors:\n- A restructuring charge associated with reducing the scope of Meridian's mortgage servicing-related activities and an increase in the provision for possible credit losses on mortgage servicing portfolios with recourse, which aggregated $22.5 million, as previously described in the \"Primary Business Activities\" section.\n- One-time expenses of $11.9 million relating to the merger with Commonwealth, as previously described in the \"Financial Highlights\" section.\nExclusive of these changes in 1993, other expenses would have increased by $40.6 million or 7% between the two years.\nSalaries, which represent the largest component of other expenses, increased by 13% during the year, from $212.4 million in 1992 to $239.4 million in 1993. An increase in staff levels, primarily in the banking unit because of acquisitions over the past year and in the broker-dealer and investment banking function because of ongoing expansion, an increase in commissions and other incentive-related compensation, and merit increases for employees contributed to the increase in salaries. Full-time equivalent employment was 6,917 at December 31, 1993 compared to 6,741 a year ago, an increase of 176 or 3%. Higher staff levels in the banking branch system accounted for one-half of this increase.\nMeridian currently provides postretirement health care and life insurance benefits to employees. The medical portion is contributory and life insurance coverage is non-contributory to the participants. Effective January 1, 1993, Meridian adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The new accounting rules require the accrual of the expected cost of these benefits over the period the employee earns the benefits. Meridian elected to defer and amortize over 20 years the cumulative obligation for such benefits at the beginning of 1993. The annual expense of Meridian's postretirement benefits other than pensions under these new accounting rules was $4.5 million in 1993 compared to approximately $2.0 million on the cash basis of accounting previously used, or an increase of $2.5 million.\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\". This statement, which becomes effective in 1994, establishes accounting standards for employers who provide benefits to former employees after employment but before retirement. Such benefits include, among other things, severance and workers' compensation benefits. Management is currently evaluating this statement and, based on the analysis to date, believes that its impact on Meridian's consolidated results of operations will not be material.\nNet occupancy expense was $42.6 million in 1993 compared to $41.3 million in 1992, an increase of 3%. Equipment expense increased from $37.1 million in 1992 to $38.0 million in 1993, an increase of 2%. The increases in both expense categories were related to expansion, banking acquisitions and the upgrading of Meridian's data processing and operations capabilities.\nThe increase in other operating expenses from $228.0 million in 1992 to $242.6 million in 1993 resulted from several factors. Loan related expenses, primarily in Meridian's mortgage banking subsidiary, increased by $8.4 million or 26% in 1993. Included in this total was an increase of $5.0 million in the provision for possible credit losses on mortgage servicing portfolios purchased with recourse. Higher premium rates increased FDIC insurance expense by $4.0 million, or 16%, between the two years. Professional fees, mostly payments to outside consultants for enhancements to operating systems, increased by $4.0 million, or 22%. Other categories reflecting increases between the two years included advertising, accounting and legal fees, and educational development expenses. Partially offsetting these increases was a decline of $12.3 million in foreclosed real estate expenses.\nPROVISION FOR INCOME TAXES\nThe provision for income taxes for 1993 was $59.1 million compared to $48.7 million for 1992. The effective tax rate, which is the ratio of income tax expense to income before income taxes, was 28% in 1993, up from 26% in 1992. The tax rate for both periods was less than the federal statutory rate of 35% in 1993 and 34% in 1992 primarily because of tax-exempt investment and loan income.\nReference should be made to Note 11 of the Notes to Consolidated Financial Statements for an additional analysis of the provision for income taxes for 1993.\nEffective January 1, 1993, Meridian adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which requires a change from the deferred method of accounting for income taxes to the liability method. Under the liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement and tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of the rate change.\nAs permitted by SFAS No. 109, Meridian has elected not to restate the financial statements of any prior years. The implementation of these new tax accounting rules resulted in an increase in consolidated net income of $7.2 million in the first quarter of 1993. This amount represents the cumulative effect of adopting this statement at the beginning of 1993. The impact of the Statement on future periods is not expected to be material.\nAt December 31, 1993, deferred tax assets amounted to $105.5 million and deferred tax liabilities amounted to $60.0 million. No valuation allowance has been established for deferred tax assets because management believes that it is more likely than not that the deferred tax assets will be realized. Deferred tax assets are realizable primarily through carryback of existing deductible temporary differences to recover taxes paid in prior years, and through future reversal of existing taxable temporary differences.\nThe Omnibus Budget Reconciliation Act of 1993 was signed into law during August 1993. The most significant change included in this act is an increase in the marginal tax rate from 34% to 35%, retroactive to the beginning of 1993. This change resulted in an increase in income tax expense. However, the benefit from Meridian's deferred tax assets, which are similar to tax loss carryforwards, was increased to reflect the higher tax rates, resulting in a one-time reduction in income tax expense. This change in deferred tax assets partially offset the increase in tax rates on operating income, resulting in a net increase of $350 thousand in income tax expense in 1993. Because of the increase in marginal tax rates on operating income, the new tax act will also have a negative effect on future periods.\nCAPITAL RESOURCES\nThe maintenance of appropriate levels of capital is a management priority. Overall capital adequacy and dividend policy are monitored on an on-going basis and are reviewed quarterly by the Board of Directors. Meridian's principal capital planning goals are to maintain a strong capital base to support the risks inherent in various lines of business, to retain sufficient earnings to meet capitalization objectives, especially those related to growth and expansion, and to provide an adequate return to shareholders. Capital is managed for each of Meridian's subsidiaries based on their respective risks and growth opportunities, as well as regulatory requirements. Meridian is positioned to take advantage of market opportunities to strengthen capital. A shelf registration with the Securities and Exchange Commission is available to facilitate the issuance of an additional $250 million of debt and preferred equity securities, if and when the need arises for capital and market conditions warrant.\nCapital ratios have increased since December 31, 1992, the result of the issuance of subordinated debt and the retention of earnings. In March, 1993, Meridian Bank issued $150 million of 6 5/8% subordinated notes due in March 2003, as previously described in the \"Long-Term Debt\" section. These notes qualify as Tier 2 capital for risk-based capital purposes.\nTotal shareholders' equity was $1,185.6 million at December 31, 1993 compared to $1,059.3 million at the end of 1992, an increase of 12%. Net income for the year was $157.8 million and dividends declared during the year were $67.5 million, resulting in a common dividend payout ratio of 43%.\nMeridian's capital adequacy at December 31, 1993 can be determined by analyzing the capital ratios presented in Table 20. As can be seen in this table, Meridian's consolidated ratios at the end of 1993 exceeded all regulatory requirements. The risk- based capital ratio was 13.67% at December 31, 1993 compared to 11.61% at December 31, 1992. The ratio of tangible shareholders' equity to assets, which excludes $96.8 million of intangible assets (goodwill, core deposit intangibles, and purchased mortgage servicing rights) was 7.78% at December 31, 1993 compared to 6.44% at December 31, 1992. The risk-based capital ratios of each of Meridian's commercial banks also exceeded regulatory requirements at the end of 1993, as shown in the table.\nFederal Reserve Board regulations define a well-capitalized institution as having a Tier 1 capital ratio of 6% or more, a total risk-based capital ratio of 10% or more, and a leverage ratio of 5% or more. Consolidated ratios at December 31, 1993 exceeded these guidelines, as did the ratios of each of Meridian's commercial banks.\nThe common stock of Meridian is traded in the over-the- counter market. The monthly average number of common shares traded in 1993 was 4.0 million compared to 3.4 million in 1992. Table 22 sets forth the high and low market price quotations for the periods indicated. Price quotations are available through the National Market System of the National Association of Securities Dealers Automated Quotation System. These prices represent quotations between dealers and do not include retail markups, markdowns or commissions, and may not represent actual transactions.\nBook value per common share was $20.39 at December 31, 1993 compared to a market value of $28.50 per share. Book value and market value at the end of 1992 were $18.75 and $31.88, respectively. The market to book value ratio was 140% at the end of 1993 compared to 170% one year ago.\nMeridian's market capitalization at December 31, 1993 was approximately $1.7 billion compared to $1.8 billion one year ago, a decrease of 8.4%. Market capitalization represented 12% of total assets at year-end 1993 and 13% at year-end of 1992.\nReference should be made to the Statement of Changes in Shareholders' Equity appearing in the Consolidated Financial Statements for a summary of the changes in total shareholders' equity for each of the years in the three-year period ended December 31, 1993.\nIn January 1994, Meridian announced the repurchase of up to one million shares of common stock from time to time in transactions in the open market or in privately negotiated transactions. Repurchased shares will be used to satisfy the obligation under warrants to acquire 500,000 shares of Meridian's common stock issuable in connection with the acquisition of McGlinn Capital Management, Inc. announced in the fourth quarter of 1993, and Meridian's obligations under present and future employee stock option and other employee benefit plans. These actions are expected to decrease the risk-based capital ratio by approximately 25 basis points by the end of 1994.\nANALYSIS OF 1992 COMPARED TO 1991\nFinancial Highlights. Net income was $136.7 million in 1992 compared to $117.7 million in 1991. The increase in earnings occurred despite an after-tax gain in 1991 of $26.8 million on the sale of Meridian's credit card portfolio. Net income in 1991 was reduced by a loss of $6.5 million from Meridian's discontinued title insurance operations.\nThe improvement in earnings resulted primarily from the following factors:\n- An increase of $73.2 million in the net interest income.\n- A reduction of $38.0 million in the provision for possible loan losses.\n- An increase in net income of $4.4 million in the securities unit, from $11.1 million in 1991 to $15.5 million in 1992.\nThe improvement in earnings was achieved despite a net loss of $9.0 million from the mortgage banking unit, compared to net income of $7.6 million in 1991.\nIncome from continuing operations was $136.7 million in 1992 compared to $124.2 million in 1991. The returns on average assets and on average common shareholders' equity in 1992 were 1.00% and 13.63%, respectively, compared to .96% and 14.31%, respectively, in 1991. The improvement in income from continuing operations between the two years resulted primarily from the factors described previously.\nTotal assets at December 31, 1992 were $14.3 billion compared to $13.2 billion at December 31, 1991. Total loans increased 1% to $8.6 billion at December 31, 1992. An increase in consumer loans more than offset declines in the commercial and residential mortgage loan portfolios. Total deposits increased by 8% from $10.9 billion at the end of 1991 to $11.8 billion at December 31, 1992.\nThe ratio of shareholders' equity to assets was 7.41% at December 31, 1992 compared to 7.18% at the end of 1991. Meridian's risk-based capital ratio was 11.61% at December 31, 1992 compared to 10.37% at the end of 1991.\nBook value per common share was $18.75 at December 31, 1992 compared to $17.21 at December 31, 1991.\nNet Interest Income and Related Assets and Liabilities. Net interest income on a taxable equivalent basis increased 13% from $526.2 million in 1991 to $594.0 million in 1992. Widening spreads between the yields on interest-earning assets and the cost of interest-bearing liabilities and an increase in interest- earning assets produced a net interest margin on a taxable- equivalent basis of 4.77% in 1992 compared to 4.47% in 1991.\nInterest-earning assets averaged $12.5 billion in 1992, 6% above the 1991 level. The increase resulted primarily from three banking acquisitions which were completed during the year. The net interest margin improved between the two years, mostly because rates on interest-bearing liabilities decreased faster than yields on interest-earning assets in the declining rate environment during this period.\nAverage loans outstanding were $8.4 billion in 1992 compared to $8.8 billion in 1991, a 4% decline. Average commercial loans decreased by 3% between the two years because of continued weak loan demand in Meridian's marketplace. Average residential real estate mortgage loans declined by 20%. Accelerated prepayments of mortgages in the low interest rate environment during 1992, together with the decision in late 1991 to securitize and sell approximately $121 million of mortgage loans, were the main reasons for this decline. Average consumer loans increased 3%, with strong growth in installment loans partially offset by the impact of the sale of Meridian's credit card portfolio in mid- 1991.\nAverage deposits were $11.3 billion in 1992 compared to $10.6 billion in 1991, an increase of 7%, primarily as a result of three banking acquisitions.\nProvision for Possible Loan Losses and Related Credit Quality. The provision for possible loan losses was $68.8 million in 1992 compared to $106.8 million in 1991. The decline of $38.0 million resulted primarily from an improvement in loan quality. While the decline between the two years was significant, its positive impact on earnings was partially reduced by an increase of $16.0 million in writedowns and other expenses associated with foreclosed real estate. Net loans charged-off were $84.6 million in 1992 compared to $85.1 million in 1991. The balance in the allowance for possible loan losses was $165.5 million or 115% of non-performing loans at December 31, 1992 compared to $179.2 million and 106% at the end of 1991.\nOther Income. Other income was $242.9 million in 1992 compared to $261.2 million in 1991. The gain of $40.6 million from the sale of the credit card portfolio is included in this category in 1991. Without this non-recurring transaction, other income would have increased by 10% between the two years.\nRevenues from the mortgage banking, asset management, and securities activities were $140.4 million in 1992, an increase of $24.8 million, or 21%, over revenues of 1991. Most of the increase was in the securities unit and related to higher levels of trading gains from sales of securities and mortgage loans and higher tender option bond fees and commission income. Service charges on deposits and fees for other customer services increased by $8.7 million, or 11%, between the two years.\nOther Expenses. Other expenses were $561.9 million in 1992 compared to $486.4 million in 1991, an increase of 16%. Approximately one-half of the increase relates to additional credit-related reserves, writedowns of foreclosed real estate, and higher operating expenses in Meridian's mortgage banking subsidiary. Operating expenses in the broker-dealer and investment banking unit increased between the two years because of the ongoing expansion of the unit. In the banking subsidiaries, increases were experienced in foreclosed real estate expenses and in operating costs from banking acquisitions that added fourteen branches to Meridian's network in 1992.\nSalaries and employee benefits were $255.5 million in 1992 compared to $235.2 million in 1991, an increase of 9%. Staff levels increased in all of the major business units, either because of acquisitions or because of an increase in business activity.\nNet occupancy expense was $41.3 million in 1992 compared to $39.6 million in 1991, an increase of 4%. Equipment expense increased from $32.8 million in 1991 to $37.1 million in 1992, or 13%. The increases in both expense categories were related to expansion, banking acquisitions and the upgrading of Meridian's data processing and operations capabilities.\nThe increase in other operating expenses from $178.7 million in 1991 to $228.0 million in 1992 resulted from several factors. Loan related expenses, primarily in Meridian's mortgage banking subsidiary, increased by $16.3 million, or 98%, in 1992. Included in this total was an increase of $9.6 million in the provision for possible credit losses on mortgage servicing portfolios purchased with recourse. These reserves, as well as $6.3 million of the following increase in expenses related to foreclosed real estate, resulted mainly from financial difficulties of certain banks and thrifts from which this servicing was purchased. Foreclosed real estate expenses, including writedowns, were $23.3 million in 1992 compared to $7.2 million in 1991. Higher premium rates and deposit levels increased FDIC insurance expense by $3.3 million, or 15%, between the two years. Amortization of intangible assets increased by $2.7 million, mostly because of banking acquisitions.\nProvision for Income Taxes. The effective tax rate was 26% in 1992, unchanged from the rate in 1991. The tax rate for both periods was less than the federal statutory rate of 34% primarily because of tax-exempt investment and loan income.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n1) Summary of Significant Accounting Policies\nThe following is a description of the more significant accounting policies and reporting practices of Meridian Bancorp, Inc. and its subsidiaries (Meridian). They are in accordance with generally accepted accounting principles and have been followed on a consistent basis, except for the accounting changes described in Notes 8 and 11.\nBasis of Presentation\nThe consolidated financial statements include the accounts of Meridian Bancorp, Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nOn August 31, 1993, Meridian acquired Commonwealth Bancshares Corporation (Commonwealth). The acquisition of Commonwealth was accounted for as a pooling of interests and resulted in the issuance of 10,946,000 shares of Meridian's common stock. Commonwealth had assets of $2.2 billion and deposits of $1.6 billion at August 31, 1993. Financial information for all prior periods presented has been restated to include the results of operations and financial position of Commonwealth.\nCertain other amounts in prior period financial statements have been reclassified to conform with the presentation used in the 1993 financial statements. These reclassifications have no effect on net income.\nCash and Cash Equivalents\nIn the accompanying Consolidated and Parent Company Statements of Cash Flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold, and securities purchased under agreements to resell. The original maturities of such instruments are less than 90 days. Federal funds are sold and securities are purchased under agreements to resell for generally one-day periods.\nInvestment Securities\nSecurities, other than securities classified as available for sale and marketable equity securities, are carried at amortized cost when Meridian has the intent and the ability at the time of purchase to hold such securities until maturity.\nSecurities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at the lower of aggregate amortized cost or fair value. Decisions to dispose of these securities are based on an assessment of economic and financial conditions affecting Meridian's financial position, including interest rate risk and the resultant prepayment risk, liquidity, capital adequacy, an evaluation of alternative asset and liability management strategies, regulatory requirements, and tax considerations. This category of securities was established during the third quarter of 1992.\nThe amortization of premiums and accretion of discounts to the expected maturity date of the related debt obligations are based on a method which approximates a constant yield.\nMarketable equity securities are carried at the lower of aggregate cost or fair value. Unrealized losses on marketable equity securities that are considered temporary in nature are recorded as a reduction of shareholders' equity.\nWhen a determination is made that the decline in fair value below cost for a marketable equity or debt security is other than temporary, the cost basis of the individual security is written down to a new cost basis and the amount of the write-down is accounted for as a realized loss.\nGains and losses on the sale of securities are computed on the specific identification method.\nTrading account securities are carried at fair value and unrealized gains or losses are included in the Consolidated Statements of Income.\nEffective in the first quarter 1994, Meridian will adopt Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\",which requires investments in equity securities with a readily determinable fair value and investments in all debt securities to be classified, at the date of adoption, in one of three categories. The three categories are (1) held to maturity -- carried at amortized cost; (2) available for sale -- carried at fair value (with unrealized gains and losses, net of related tax effect, recorded as a separate component of shareholders' equity); and (3) trading account - carried at fair value (with unrealized gains and losses recorded in the income statement). The impact of this accounting change, had Meridian elected to adopt this statement at December 31, 1993, would have been to increase shareholders' equity by approximately $8.1 million, or less than 1%, representing the after-tax unrealized gain in the available for sale portfolio.\nInterest Rate Swaps\nInterest rate swaps, the principal derivative product used by Meridian, are a tool used mainly to alter the repricing characteristics of a portion of the core deposit base. There is no effect on the recorded total assets or liabilities of Meridian. Net amounts receivable or payable under agreements designated as hedges are recorded as adjustments to the interest income or expense related to the hedged asset or liability. Related fees are deferred and amortized over the term of the swap agreement. Gains or losses resulting from the termination of interest rate swaps are deferred and amortized over the remaining term of the hedged asset or liability.\nLoans\nLoans are stated net of deferred fees and costs and unearned discount. Loan interest income is accrued using various methods which approximate a constant yield.\nInterest income is not accrued on commercial loans where management has determined that borrowers may be unable to meet contractual principal or interest payments, or where such payments are 90 or more days past due unless the loan is well secured and in the process of collection. Interest on loans that have been restructured is recognized according to the renegotiated terms.\nResidential mortgages which are 180 days or more delinquent are placed on nonaccrual status when total principal, interest, and escrow owed exceeds 80% of the property's appraised value. Properties are re-appraised when foreclosure proceedings are initiated.\nLoan origination and commitment fees and direct loan origination costs are deferred and recognized over the life of the related loans as an element of the yield.\nStatement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\" requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the underlying collateral. This statement is effective for fiscal years beginning after December 15, 1994 and, based on the analysis to date, management believes that the impact on Meridian's consolidated results will not be material.\nAllowance for Possible Loan Losses\nThe allowance for possible loan losses is established through provisions for possible loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance. Subsequent recoveries, if any, are credited to the allowance.\nThe balance in the allowance is based on a periodic evaluation of the loan portfolio and reflects an amount that in management's opinion is adequate to absorb losses inherent in the portfolio.\nWhen establishing the appropriate levels for the provision and the allowance for possible loan losses, management performs an analysis of the loan portfolio by considering a variety of factors. This analysis includes periodic reviews by loan review and loan workout personnel of all borrowers with aggregate balances of $250,000 or greater. Meridian also reviews, at least on a quarterly basis, problem borrowers with balances of $500,000 or greater, as well as selected lower balance loans. Consideration is given to the impact of current and anticipated economic conditions, the diversification of the loan portfolio, historical loss experience, delinquency statistics, reviews performed by loan officers who are primarily responsible for compliance with established lending policy, the perceived financial strength of borrowers, and the perceived adequacy of underlying collateral. Consideration is also given to examinations performed by regulatory authorities.\nPremises and Equipment\nPremises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed on the straight line method and is charged to operations over the estimated useful lives of the related assets. Leasehold improvements are amortized on a straight line basis over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter.\nOther Assets\nGoodwill is the excess of the purchase price over the fair value of net assets of companies acquired through business combinations accounted for as purchases. Included in other assets is $35.0 million of goodwill that is being amortized using the straight line method over various periods not exceeding 18 years.\nCore deposit intangibles are a measure of the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. Included in other assets is $21.9 million of core deposit intangibles which are being amortized on an accelerated method, with at least two- thirds of the original balance being amortized within seven years following the date of acquisition.\nThe recoverability of the carrying value of intangible assets is evaluated on an ongoing basis and permanent declines in value, if any, are charged to expense.\nAssets acquired in foreclosures consist of real estate acquired through foreclosure or in settlement of debt and loans considered to be in an in-substance foreclosure status. These assets are carried at the lower of cost or fair value less estimated costs of disposal.\nTrust Assets\nAssets held by Meridian in a fiduciary or agency capacity for customers are not included in the consolidated financial statements since such items are not assets of Meridian or its subsidiaries. Trust income is reported on the accrual method.\nMortgage Banking\nMortgage servicing fees received from permanent investors for servicing their loan portfolios are recorded as income when received. Mortgage loan servicing includes collecting monthly mortgagor payments, forwarding payments and related accounting reports to investors, collecting escrow deposits for the payment of mortgagor property taxes and insurance, and paying taxes and insurance from escrow funds when due.\nIn the third quarter of 1993 Meridian decided to refocus its mortgage activities on the origination of residential loans and to substantially reduce the scope of its mortgage servicing business. Mortgage servicing intangibles and other related assets are carried at fair value and are included in mortgage loans and other assets held for sale in the consolidated balance sheets.\nAcquisition costs of mortgage servicing rights purchased prior to the third quarter of 1993 were capitalized and amortized in proportion to, and over the period of, estimated net servicing revenue (undiscounted servicing revenues in excess of undiscounted servicing costs). In estimating future servicing revenues, management takes into consideration a number of factors including the current rate of anticipated prepayments of the underlying mortgage loans. Changes in the assumptions used could significantly affect management's estimates. If actual results differed significantly from those estimated by management, adjustments to the carrying value of purchased mortgage servicing rights could occur.\nExcess servicing fees are computed as the present value of the difference between the estimated future net revenues and normal servicing revenues as established by the federally sponsored secondary market makers. Resultant premiums are deferred and amortized over the estimated life of the related mortgages using the constant yield method.\nThe amortization of both purchased mortgage servicing rights and excess servicing fees is recorded as a reduction of servicing revenue.\nMortgage loans and other assets held for sale are carried at the lower of aggregate cost or fair value, with resulting gains and losses included in other income. The fair value calculation includes consideration of all open positions, outstanding commitments from investors and related fees paid.\nSecurities Operations\nForward rate agreements (commitments to sell securities) and tender option bonds (commitments to purchase securities) are off- balance sheet items that represent contingent liabilities and are therefore not included in the consolidated financial statements. Realized gains and losses and net interest spread income on these instruments are included in other income. Securities designated to cover forward rate agreements are included in trading account securities and are carried at the lower of cost or contract price. Collateralized mortgage obligation residuals, rights acquisition contracts and guaranteed interest rate contracts are other financial instruments and are included in the consolidated financial statements in investment securities, investment securities available for sale and interest-bearing deposits, respectively.\nIncome Taxes\nCertain items of income and expense are included in one reporting period for financial accounting purposes and another reporting period for income tax purposes. Under the liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement and tax bases of existing assets and liabilities.\nPostretirement Benefits\nMeridian has a non-contributory defined benefit pension plan covering substantially all employees who qualify as to age and length of service. The plan benefits are based on years of service and an earnings formula that considers average salaries during a defined period prior to retirement.\nThe projected unit credit method is used to measure net periodic pension cost over employees' service lives. The plan is funded using the entry age actuarial cost method to the extent deductible under existing federal income tax regulations.\nMeridian currently provides postretirement health care and life insurance benefits to its employees. The medical portion is contributory and life insurance coverage is non-contributory to the participants. The expected cost of these benefits is accrued over the period the employee earns the benefits. There are currently no plan assets attributable to these postretirement benefits.\nPreferred Stock\nMeridian has 25 million shares of preferred stock authorized that carries a $25.00 par value per share. No shares of preferred stock were issued and outstanding as of December 31, 1993. Meridian's Board of Directors has the authority to issue the preferred stock from time to time as a class without series, or in one or more series.\nCommon Stock Dividends\nMeridian adopted a new dividend payment schedule effective in 1992. In addition to the dividend of $.30 per share paid on January 1, 1992 (declared November 1991), the Board of Directors also declared dividends of $.30 per share in April, July and October 1992 for payment on June 1, September 1 and December 1, 1992, respectively. Accordingly, a dividend was not declared in the quarter ended March 31, 1992.\nEarnings Per Share\nPrimary earnings per share is computed by dividing net income after deduction of any preferred stock dividends by the weighted average number of common stock and common stock equivalents outstanding during the year. Stock options are considered common stock equivalents and are included in the computation of the number of outstanding shares using the treasury stock method, unless such options are anti-dilutive Fully diluted earnings per share gives effect to the assumed conversion of any convertible preferred stock as well as to the exercise of stock options.\nNet income and dividends per common share and average shares outstanding for the last three years are as follows:\n2) ACQUISITIONS\nThe merger with Commonwealth on August 31, 1993 was accounted for as a pooling-of-interests and resulted in the issuance of 10,946,000 shares of Meridian common stock. Financial information for all prior periods presented has been restated to include the results of operations and financial position of Commonwealth. A reconciliation of amounts, as previously reported for 1992 and 1991, to the consolidated amounts reported in the accompanying financial statements is as follows (dollars in thousands, except per share data):\nIn April 1993, Meridian acquired all of the outstanding common shares of Cherry Hill National Bank of Medford, New Jersey. The acquisition was accounted for as a pooling-of- interests and resulted in the issuance of 477,000 shares of Meridian's common stock. Cherry Hill had assets of $113 million and deposits of $101 million at the time of the merger.\nIn November 1993, Meridian Bank assumed approximately $76 million of deposits of Provident Savings Bank of Jersey City, and paid a premium of $540 thousand. This acquisition was accounted for as a purchase.\nIn December 1993, Meridian, acquired all of the outstanding common shares of First Bath Corp. The acquisition was accounted for as a pooling-of-interests and resulted in the issuance of 565,000 shares of Meridian's common stock. First Bath had assets of approximately $120 million and deposits of $110 million at the time of the merger.\nThe above four acquisitions added 74 new branches to Meridian's branch network.\nOn July 9, 1992 Meridian entered into an agreement to acquire 21 branches in seven counties of central and southern New Jersey of Security Savings Bank, SLA, a wholly-owned subsidiary of Security Investments Group, Inc. Under the terms of the agreement, Meridian was to have acquired selected nonclassified and performing assets and real estate. On December 4, 1992, the Office of Thrift Supervision declared Security insolvent and placed it in receivership with the Resolution Trust Corporation which, in its capacity as receiver of Security, repudiated the agreement with Meridian during the fourth quarter of 1993.\nOn December 16, 1993, Meridian entered into a definitive agreement to acquire McGlinn Capital Management, Inc., an investment advisory firm with $2.8 billion in assets under direct management, for 500,000 warrants for shares of Meridian common stock and cash. The transaction, which is subject to regulatory approval, is expected to be completed by the end of the second quarter of 1994. 3) INVESTMENT SECURITIES, INVESTMENT SECURITIES AVAILABLE FOR SALE AND SECURITIES GAINS\nA summary of the carrying value and approximate fair value of investment securities included in the Consolidated Balance Sheets is as follows:\nA summary of the gross unrealized gains and losses on investment securities is as follows:\nThe carrying value and approximate fair value of investment securities at December 31, 1993 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations.\nInvestment securities carried at approximately $1.8 billion at December 31, 1993 were pledged as collateral for public deposits, trust deposits, repurchase agreements, and certain other deposits as required by law. No securities of an individual issuer aggregated more than 10% of shareholders' equity at December 31, 1993. Tax-free income on investment securities for 1993, 1992 and 1991 amounted to $20.6 million, $21.8 million and $28.4 million, respectively.\nINVESTMENT SECURITIES AVAILABLE FOR SALE\nA summary of the carrying value, approximate fair value and gross unrealized gains and losses of investment securities available for sale included in the Consolidated Balance Sheets is as follows. This category of securities was established during the third quarter of 1992.\nThe carrying value and approximate fair value of investment securities available for sale at December 31, 1993 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations.\nTOTAL SECURITIES GAINS\nTotal gains from securities transactions, which were included in the following categories in the other income section of the consolidated statements of income, are as follows:\nNet securities gains included gross gains of $25.5 million, $6.1 million, $9.8 million and gross losses of $203 thousand, $3.4 million and $5.9 million during 1993, 1992 and 1991, respectively. Securities gains in 1993 include a gain of $8.6 million on the sale of Meridian's common stock investment in Fidelity National Financial, Inc. This stock was acquired as part of the sale of Meridian's title insurance operations in 1992. Exclusive of this gain, securities gains in 1993 resulted primarily from sales of investments classified as available for sale.\n4) Loans\nA summary of loans included in the Consolidated Balance Sheets is as follows:\nIncluded within the loan portfolio are restructured loans and loans on which Meridian has discontinued the accrual of interest. Such loans amounted to $127.6 million, $143.6 million, and $169.3 million at December 31, 1993, 1992, and 1991, respectively. If these non-performing loans had been current in accordance with their original terms and had been outstanding throughout the period, gross interest income for 1993, 1992, and 1991 would have increased $9.5 million, $13.5 million, and $19.2 million, respectively. Interest income on these non-performing loans included in income for 1993, 1992, and 1991 amounted to $706.0 thousand, $3.1 million, and $1.5 million, respectively.\nTax-free income on loans for 1993, 1992, and 1991 amounted to $14.4 million, $16.6 million, and $22.2 million, respectively.\nThe aggregate amount of loans by Meridian to its directors and executive officers, including loans to related persons and entities, was $37.1 million at December 31, 1993 and $54.9 million at December 31, 1992. These loans were made in the ordinary course of business at substantially the same terms and conditions as those with other borrowers and did not involve more than the normal risk of collectibility. An analysis of the activity in 1993 for these loans follows:\nOther, Net includes the addition of loans to new directors and officers and the reductions in loans because of persons who no longer meet the criteria for classification as a related person or entity.\n5) Allowance for Possible Loan Losses\nA summary of activity in the allowance for possible loan losses follows:\n6) SHORT-TERM BORROWINGS AND LONG-TERM DEBT AND OTHER BORROWINGS\nShort-term borrowings consisted of the following:\nMeridian had unused lines of credit of $30 million and $202 million at December 31, 1993 and 1992, respectively.\nThe table below provides outstanding balances and related information for federal funds purchased and securities sold under repurchase agreements. Average interest rates for the year are computed by dividing interest expense by the respective average daily balances.\nLong-term debt and other borrowings consisted of the following:\nThe floating rate subordinated notes bear interest at a rate of 1/8 of 1% above the arithmetic mean of London interbank offering quotations for three-month Eurodollar deposits, determined quarterly. The notes carry a floor interest rate of 5 1/8%. The notes are subordinate and junior in right of payment of senior indebtedness of Meridian. Since December 1, 1988, Meridian has had the option to exchange of the notes for capital securities, or under certain circumstances, cash, prior to maturity of the notes on December 1, 1996. The effect of the capital securities which may be issued in connection with these notes has not been included in the computation of earnings per share. In December, 1993, Meridian received approval from the Federal Reserve Bank to revoke its obligation to exchange the notes for capital securities at maturity.\nDuring 1993, Meridian Bank, Meridian's principal banking subsidiary, sold $150 million of 6.625% fixed rate subordinated notes due March 15, 2003. The net proceeds are being used for general corporate purposes, including possible branch acquisitions and other acquisitions of all or portions of failed institutions from the Resolution Trust Corporation or the Federal Deposit Insurance Corporation.\nMeridian has long-term borrowings from the Federal Home Loan Bank which total $75 million. These borrowings require Meridian to maintain membership in the Federal Home Loan Bank of Pittsburgh and to maintain collateral with a fair value which approximates the total amount of the outstanding debt.\nThe remaining long-term debt consists of debt of Meridian's banking subsidiaries and is subordinated in the right of payment to the depositors of such subsidiaries. Substantially all of the notes are redeemable prior to maturity at certain amounts based on sinking fund provisions or, when applicable, approval of the appropriate regulatory agency.\n7) DIVIDEND, CAPITAL AND OTHER REGULATORY RESTRICTIONS\nVarious laws restrict the amount of dividends that can be paid to Meridian by its subsidiary banks without regulatory approval. Under current regulations, Meridian's subsidiary banks, without prior approval of bank regulators, may declare dividends to Meridian in 1994 totalling approximately $147.1 million plus additional amounts equal to the net profits earned by such subsidiary banks for the period from January 1, 1994, through the date of declaration, less dividends previously paid in 1994.\nMeridian is required to maintain minimum amounts of capital to total \"risk weighted\" assets, as defined by the banking regulators. Meridian is required to have minimum Tier 1 and total capital ratios of 4.00% and 8.00%, respectively. Meridian's actual ratios at December 31, 1993 were 9.60% and 13.67%, respectively, well above regulatory requirements. Meridian is also required to maintain a leverage ratio of 3% plus an additional cushion of 100 to 200 basis points. Meridian's leverage ratio at December 31, 1993 was 7.84%.\nThe Federal Reserve Act also places restrictions on the amount of credit that may be extended to Meridian by its subsidiary banks. During 1993, there were no loans or advances made to Meridian by any of its subsidiary banks.\nMeridian's banking subsidiaries are required to maintain reserve balances with the Federal Reserve. These balances totalled $94.3 million at December 31, 1993 and averaged $91.6 million for the year then ended.\n8) EMPLOYEE BENEFIT PLANS\nPension Plans\nTotal pension expense for 1993, which includes several informal pension arrangements in addition to the Meridian and Commonwealth plans, was $2.9 million. Total pension expense for 1992 and 1991 was $59 thousand and $2.5 million, respectively. Pension expense in 1992 reflects significantly better than expected investment returns on plan assets.\nNet periodic pension expense (credit) of the Meridian and Commonwealth plans includes the following components:\nThe following table sets forth the funded status of the Meridian and Commonwealth plans and amounts recognized in the Consolidated Balance Sheets at December 31.\nNet periodic pension expense is determined using certain assumptions as of the beginning of the year whereas the funded status of the plan is determined using assumptions as of the end of the year.\nThe discount rate used in determining the actuarial present value of Meridian's projected benefit obligation was 7.0% in 1993 and 8.0% in 1992 and 1991. The expected long-term rate of return on plan assets was 9.5% in 1993, 1992 and 1991. The rate of increase in future compensation levels was 5.3% in 1993 and 6.3% in 1992 and 1991.\nThe discount rate used in determining the actuarial present value of Commonwealth's projected benefit obligation was 7.0% in 1993, 7.5% in 1992 and 8.0% in 1991. The expected long-term rate of return on plan assets was 9.5% in 1993, 8.0% in 1992 and 9.0% in 1991. The rate of increase in future compensation levels was 5.3% in 1993 and 5.25% in 1992 and 1991.\nThe assets of the Meridian and Commonwealth plans are administered by Meridian Asset Management, Inc., and consist primarily of common stock, fixed income securities such as obligations of the United States government and corporations, and units of certain common trust funds.\nMeridian provides postretirement health care and life insurance plans to its employees. The medical portion is contributory and life insurance coverage is noncontributory to the participants. Effective January 1, 1993, Meridian adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The new accounting rules require the accrual of the expected cost of these benefits over the period the employee earns the benefits. Meridian elected to defer and amortize over 20 years the cumulative obligation for such benefits at the beginning of 1993.\nThe annual expense of Meridian's postretirement benefits other than pensions under these new accounting rules was $4.5 million in 1993 compared to approximately $2.0 million on the cash basis of accounting previously used, or an increase of $2.5 million. The health care trend rate assumption used to determine accumulated benefit obligations applicable to these benefits was 11% for 1993 decreasing over time to an annual rate of 5.5% and remaining at that level thereafter. The discount rate used in determining the present value of the projected benefit obligation was 7%.\nNet periodic expense of the Meridian and Commonwealth postretirement healthcare and life insurance plans includes the following components:\nThe following table sets forth the funded status of the Meridian and Commonwealth postretirement healthcare and life insurance plans and amounts recognized in the Consolidated Balance Sheets at December 31. There are currently no plan assets attributable to these postretirement benefits.\nA change in the health care trend rate assumption of one percent would increase annual service cost by approximately $100,000 and the accumulated postretirement benefit obligation at December 31, 1993 by approximately $800,000.\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\". This statement, which becomes effective in 1994, establishes accounting standards for employers who provide benefits to former employees after employment but before retirement. Such benefits include, among other things, severance and workers' compensation benefits. Management is currently evaluating this statement and, based on the analysis to date, believes that its impact on Meridian's consolidated results of operations will not be material.\nSavings Plan\nMeridian also offers a savings plan which covers substantially all employees who qualify as to age and length of service. A participating employee must contribute at least 1% and may contribute a maximum of 10% of his or her compensation. Meridian will match up to the first 6% that each employee contributes. Investment options include Meridian common stock. Contributions are charged to current expense. The total expense relating to the Meridian savings plan was $7.1 million in 1993, $6.5 million in 1992 and $5.7 million in 1991.\nStock Option Plan\nUnder Meridian's stock option plan, options to acquire a maximum of 3,500,000 shares of common stock may be granted to key officers. The plan provides for the granting of options at the fair market value of Meridian's common stock at the time the options are granted. Each option granted under the plan may be exercised within a period of ten years from the date of the grant; however, no option may be exercised within one year from the date of grant.\nA stock appreciation rights (SARs) plan grants SARs in tandem with stock option grants, up to a maximum of 750,000 units. The exercise of SARs reduces the stock options otherwise exercisable; similarly, the exercise of stock options cancels the corresponding SARs. There were no SARs outstanding at December 31, 1993.\nUnder Meridian's stock option plan, the exercisable option prices ranged from $10.50 to $31.12 at December 31, 1993. An analysis of the activity in this plan for the last three years follows:\nTotal rental expense for all operating leases for 1993, 1992 and 1991 amounted to $20.5 million, $18.2 million, and $16.4 million, respectively.\n10) OTHER OPERATING EXPENSES\nThe following represents the most significant categories of other operating expenses for the years ended December 31:\n11) INCOME TAXES\nEffective January 1, 1993, Meridian adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109),which requires a change from the deferred method of accounting for income taxes to the liability method. Under the liability method, deferred tax assets and liabilities are recognized for future tax consequences attributable to temporary differences between the financial statement and tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date of the rate change.\nAs permitted by SFAS No. 109, Meridian has elected not to restate the financial statements of any prior years. The implementation of these new tax accounting rules resulted in an increase in consolidated net income of $7.2 million in the first quarter of 1993. This amount represents the cumulative effect of adopting SFAS No. 109 at the beginning of 1993. The impact of SFAS No. 109 on future periods is not expected to be material.\nAt December 31, 1993, deferred tax assets amounted to $105.5 million and deferred tax liabilities amounted to $60 million. No valuation allowance has been established for deferred tax assets because management believes that it is more likely than not that the deferred tax assets will be realized. Deferred tax assets are realizable primarily through carryback of existing deductible temporary differences to recover taxes paid in prior years and through future reversal of existing taxable temporary differences.\nThe Omnibus Budget Reconciliation Act of 1993 was signed into law during August 1993. The most significant change included in this act is an increase in the marginal tax rate from 34% to 35%, retroactive to the beginning of 1993. This change resulted in an increase in income tax expense. However, the benefit from Meridian's deferred tax assets, which are similar to tax loss carryforwards, was increased to reflect the higher tax rates, resulting in a one-time reduction in income tax expense. This change in deferred tax assets partially offset the increase in tax rates on operating income, resulting in a net increase of $350 thousand in income tax expense in 1993. Because of the increase in marginal tax rates on operating income, the new tax act will also have a negative effect on future periods.\nThe provision for income taxes on continuing operations consists of the following:\nThe effective tax rate is less than the federal statutory rate in each year as a result of the following items:\nThe significant components of deferred income tax expense attributable to income from continuing operations for the year ended December 31, 1993 are as follows:\nFor the years ended December 31, 1992 and 1991, deferred income tax benefit of $6.6 and $5.6 million, respectively, results from timing differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax effects of those timing differences are presented below:\nThe components of the deferred tax asset and liabilities are as follows:\n12) Commitments and Contingencies\nFinancial Instruments with Off-Balance-Sheet Risk\nMeridian uses various financial instruments in conducting its business activities and in managing its balance sheet risks. These instruments are properly not included in the accompanying consolidated financial statements. The instruments involve, to varying degrees, elements of credit risk, interest rate risk, and liquidity risk.\nA summary of the contractual or notional amounts of these financial instruments along with a discussion of the instruments and their underlying risk characteristics is as follows:\nMeridian extends binding loan commitments to prospective borrowers. Such commitments assure the borrower of financing for a specified period of time or at a specified rate and usually require the payment of a fee. The risk to Meridian in an undrawn loan commitment is limited by the terms of the contract. For example, Meridian may not be obligated to advance funds if the customer's financial condition deteriorates or if the customer fails to meet specific covenants. An undrawn loan commitment represents both a potential credit risk once the funds are advanced to the customer and liquidity risk since the customer may demand immediate cash that would require a funding source. Meridian's credit review and approval process for loan commitments is the same as the process used for loans. In addition, Meridian's Credit Policy Committee reviews customer requests for loan commitments and monitors outstanding commitments on an ongoing basis. Meridian's current liquidity position continues to satisfy its needs for funds. In addition, since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time will not require a funding source.\nA standby letter of credit is an instrument issued by a bank that represents an obligation to guarantee payments on certain transactions of its customers. Meridian evaluates the creditworthiness of each of its letter of credit customers, using the same review and approval process that is used for loans. In addition, Meridian has established guidelines limiting the amount of total outstanding standby letters of credit to a specified percentage of its shareholders' equity. Compliance with these guidelines is monitored on a monthly basis.\nThe amount of collateral received on loan commitments and on standby letters of credit is dependent upon the individual transaction and the creditworthiness of the customer.\nMeridian originates and sells residential mortgage loans as part of various mortgage-backed security programs sponsored by United States government agencies or government-sponsored agencies, such as the Government National Mortgage Association, Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association. These sales are often subject to certain recourse provisions in the event of default by the borrower. Meridian provides for potential losses against these mortgage- backed securities by establishing reserves at the time of sale and evaluates the adequacy of these reserves on an ongoing basis.\nForward rate agreements are used in transactions with municipalities that generally have a debt payment due in the future. Under these agreements, Meridian agrees to deliver primarily securities, usually United States Treasury securities, that will mature on or before the required payment date. The type and associated interest rate of these securities is established when the agreement is entered into.\nThe principal risk associated with forward rate agreements is interest rate risk to the extent the required securities have not been purchased. If interest rates fall, securities yielding the higher agreed upon fixed rate will be more expensive for Meridian to purchase.\nMeridian has commitments to sell mortgage-backed securities or loans with delivery at a future date but typically within 120 days. The risk associated with these instruments consists primarily of loans not closing in sufficient volumes and at appropriate yields to meet mandatory obligations. Meridian is also subject to interest rate risk in a decreasing rate environment. Hedges are used to decrease the impact of such risk.\nTender option bonds are also instruments associated with municipalities. A municipality generally issues a tax-free, fixed rate, long-term security in order to finance the origination of single family residential mortgages. The municipality enters into a tender option bond program with Meridian, which converts the fixed rate long-term instrument into a variable rate short-term product. Under the terms of this agreement, the municipality will pay a fixed rate to Meridian over the life of the underlying bond. Meridian, in turn, pays a short-term variable rate to the ultimate bondholder, who has the option to sell the bonds back to Meridian. Meridian also receives the right to remarket any purchased bonds at a short- term, tax-exempt, variable rate.\nThe risk to Meridian in tender option bonds is one of interest rate risk in a rising rate environment. If interest rates increase, the rate paid on the short-term instrument will also increase and the spread between the fixed rate that Meridian receives and the short-term rate Meridian pays to bondholders will decrease. If short-term rates exceed the fixed rate on the long-term instrument, then the short-term instrument will be sold at a discount and Meridian would incur a loss.\nMeridian's position in forward rate agreements and tender option bonds is sometimes hedged through the use of other interest rate sensitive financial instruments such as options. In addition, these two instruments have interest rate sensitivities that move in opposite directions.\nInterest rate swap agreements involve the exchange of fixed and floating rate interest payments without the exchange of the underlying contractual or notional amounts. Interest rate options, caps, and floors involve the receipt of a fee by Meridian in exchange for assumption of the risk of interest rate movements beyond a predetermined level. Interest rate caps or floors are written to enable customers to manage their interest rate risks.\nInterest rate swaps, the principal derivative product used by Meridian, are used as part of the asset and liability management program to alter the repricing characteristics of a portion of the core deposit base. Risk in these transactions involves the risk of counterparty nonperformance under the terms of the contract. The notional or contract amount does not represent the risks inherent in these agreements. The risk of loss can be approximated by estimating the cost, on a present value basis, of replacing an instrument at current market interest rates. Credit risk is managed by performing credit reviews and through ongoing credit monitoring procedures.\nReference should be made to Note 14 of the Notes to Consolidated Financial Statements for a discussion of contingent liabilities related to the discontinued title insurance operations.\nConcentrations of Credit Risk\nLoan concentrations are considered to exist when a multiple number of borrowers are engaged in similar activities and have similar economic characteristics which would cause their ability to meet contractual obligations to be similarly impacted by economic or other conditions. At December 31, 1993, Meridian's commercial loans and commitments did not have any industry concentration or other known concentration that exceeded 10% of total loans and commitments. However, the effect of the recent recession has had a negative impact on the financial performance of many companies involved in retail trade. At December 31, 1993 Meridian's loans to companies in retail trade totalled $721.6 million, or 8% of total loans outstanding and 13% of total commercial loans outstanding. Included in this total were loans to department stores and other retailers of $358.9 million and loans to automobile dealers of $362.7 million.\nLegal\nMeridian and certain of its subsidiaries were party (plaintiff or defendant) to a number of lawsuits. While any litigation has an element of uncertainty, management, after reviewing these actions with its legal counsel, is of the opinion that the liability, if any, resulting from all legal actions will not have a material effect on the consolidated financial condition or results of operations of Meridian.\n13) FAIR VALUES OF FINANCIAL INSTRUMENTS\nIn December 1991, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" (SFAS No. 107). SFAS No. 107 requires disclosure of the fair value of all financial instruments, whether or not recognized on the balance sheet, for which it is practicable to estimate such value. Fair value estimates and assumptions are presented below for Meridian's financial instruments.\nFair value estimates are made at a point in time, based on relevant market information and available information about the financial instrument. Fair values are based on quoted market prices for financial instruments where prices exist in the market. In cases where quoted market prices are not available, fair values are derived from estimates using present value or other valuation techniques. Because a quoted market price does not exist for a significant portion of Meridian's financial instruments, fair value estimates are based on judgments regarding future cash flow expectations, perceived credit risk, interest rate risk, prepayment risk, economic conditions, and other factors. The estimates are therefore subjective and may not reflect the amount that could be realized upon immediate sale of the instrument. Changes in the assumptions could also significantly affect the estimates. Also, the estimates do not reflect any additional premium or discount that could result from the sale of Meridian's entire holdings of a particular financial instrument.\nOnly existing on and off-balance sheet financial instruments are subject to fair value estimates. A value is not assigned to fee-based businesses such as Meridian's asset management and trust operations, with customers' assets of approximately $27.0 billion, and the mortgage banking business, where Meridian services approximately $7 billion in residential and commercial loans. In addition, core deposits represent the intangible value derived from retaining low-cost deposits for an expected future period of time. The positive value of core deposits held by Meridian is not reflected in these fair value estimates because it is not a requirement of SFAS No. 107. The value of other non- financial instruments, such as property, plant and equipment, and deferred tax assets is also not considered. In addition, tax implications related to the realization of unrealized gains and losses can significantly affect fair value and have not been considered in these estimates.\nBecause of these reasons, the aggregate fair values disclosed in this footnote to the financial statements are not meant to represent an estimate of the underlying value of Meridian Bancorp, Inc. taken as a whole.\nAt December 31, 1993 and 1992, the carrying, contract, or notional values and estimated fair values of financial instruments of Meridian are as follows:\nOff-Balance Sheet Financial Instruments\nMeridian uses various off-balance sheet financial instruments in conducting its business activities and in managing its balance sheet risks. The value of these instruments is based on their respective settlement values, or the amount that Meridian would either pay or receive to assume Meridian's position in these contracts.\nThe following methods and assumptions were used by Meridian in estimating the fair value of its financial instruments:\nCash and Due from Banks. The carrying amounts reported in the balance sheet approximate fair value due to the short-term nature of these assets.\nShort-Term Investments. Short-term investments include trading account securities which are marked-to-market for financial reporting purposes and therefore already approximate fair value. The carrying amounts of other short-term investments on Meridian's balance sheet approximate fair value since the maturity of these instruments is generally 90 days or less. For short-term investments with maturities of greater than 90 days, fair value estimates are based on market quotes for similar instruments, adjusted for such differences between the quoted instruments and the instruments being valued as maturity and credit quality.\nInvestment Securities and Investment Securities Available for Sale. The fair values of investment securities and investment securities available for sale are based on quoted market prices as of the balance sheet date, where available. In cases where a market price is not available, external pricing services that approximate fair value are used. For certain instruments, fair value is estimated by obtaining quotes from independent securities dealers.\nLoans. Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are aggregated by commercial, residential real estate, and consumer categories. Each loan portfolio is further classified by variable rate or fixed rate loans and by performing or nonperforming loans.\nFor performing variable-rate loans, fair values are based on carrying amounts, as these loans reprice frequently as market rates change. Additionally, most variable rate loans are reviewed and extended on at least an annual basis. At the time of that review, these loans are repriced to reflect the current credit risk inherent in the loan. For performing fixed-rate loans, the fair value methodology varies according to each loan portfolio. Fair values for residential real estate and consumer loans are estimated using quoted market prices, where available. Where quoted market prices are not available, quotations are obtained for similar instruments and adjusted for such differences in loan characteristics as maturity and credit quality. The fair value of performing fixed-rate commercial loans is estimated by discounting the expected cash flows by a discount rate that reflects the interest rate and credit risk inherent in the loan. The estimated maturity of these loans reflects both contractual maturity and management's assessment of prepayments, economic conditions, and other factors that may affect the maturity of the portfolio. The discount rate is based on the rate that would be currently offered for loans with similar terms to borrowers of similar credit quality.\nNonperforming loans are included in each of the loan portfolios previously described. The fair value of nonperforming loans is estimated by discounting the expected return of principal over the period of time Meridian anticipates receiving principal payments on the loan. The discount rate used is a rate reflective of the higher risk surrounding these assets compared to a performing loan.\nAccrued Interest Receivable and Other Assets. The carrying value of certain financial instruments included in these categories, such as accrued interest receivable, approximates fair value. For other financial instruments, such as assets related to servicing certain loans, fair value is estimated by discounting the scheduled cash flows through estimated maturity by a discount rate that reflects the interest rate and credit risk inherent in the instrument.\nDeposits. The fair value of deposits with no stated maturity, such as non-interest bearing deposits, NOW accounts, savings, and money market deposit accounts, is the amount payable on demand as of year end. The fair value of low-cost core deposits is not considered in the value of deposits nor is it recorded as an intangible asset in the balance sheet, as previously discussed.\nFor time deposits, fair value is estimated by discounting the contractual cash flows using a discount rate equal to the rate currently offered for similar deposits of similar maturities.\nShort-Term Borrowings. The carrying values of federal funds purchased, securities sold under agreements to repurchase, and other short-term borrowings approximate fair values.\nLong-Term Debt and Other Borrowings. The fair values of long-term debt and other borrowings are estimated by discounting the contractual cash flows for each instrument. The discount rate applied is based on the current incremental borrowing rates for similar arrangements with similar maturities.\nAccrued Interest Payable and Other Liabilities. The carrying value of certain financial instruments included in these categories, such as accrued interest payable, approximates fair value.\nOff-Balance Sheet Financial Instruments. Fair values for Meridian's off-balance sheet financial instruments are calculated based on market prices (forward rate agreements and interest rate swaps); market prices for comparable instruments, adjusted for such differences between the two instruments as maturity or credit quality (mortgage loans sold or loan servicing acquired with recourse, commitments to purchase or sell securities, tender option bonds and other interest rate contracts); and fees currently charged to enter into similar agreements, taking into account the remaining term of the agreement and the present credit risk assessment of the counterparty (commitments to extend credit and standby letters of credit).\n14) Discontinued Operations\nThe sale of Meridian's title insurance operations to Fidelity National Financial, Inc. of Irvine, California was completed on June 30, 1992.\nMeridian retained an investment of $20 million in preferred stock of American Title Insurance Company. This investment is mandatorily redeemable by American Title in 2004 and is included in other assets in the consolidated balance sheets. However, the redemption price and carrying value of the preferred stock on the books of Meridian is subject, under certain circumstances, to reduction to the extent that claims accruals or payments on title policies issued prior to year-end 1991 by American Title and certain other general litigation accruals or payments, net of recoveries, exceed reserves (approximately $46 million) on the books of American Title at December 31, 1991. Meridian is also obligated to pay an amount, up to $11 million, to the extent that claims payments, net of recoveries, by both Meridian Title Insurance Company and American Title on policies issued prior to year-end 1991 exceed the preferred stock redemption price of $20 million plus reserves (approximately $53 million) on the books of both Meridian Title and American Title at December 31, 1991.\n15) MERIDIAN BANCORP, INC. (PARENT COMPANY ONLY)\n16) Industry Segment Reporting\nMeridian operates principally in two business segments - banking and securities. Reference should be made to the discussion and tables appearing under \"Banking\" and \"Securities\" in the section \"Primary Business Activities\" in Management's Discussion and Analysis of Earnings and Financial Position for financial information on each of these business segments.\nOpinion of Independent Auditors\nThe Board of Directors Meridian Bancorp, Inc.\nWe have audited the accompanying consolidated balance sheets of Meridian Bancorp, Inc. and its subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1993. These consolidated financial statements are the responsibility of management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Meridian Bancorp, Inc. and its subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in Notes 8 and 11, respectively, to the consolidated financial statements, the Company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, in 1993.\nKPMG PEAT MARWICK January 19, 1994\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference is the following information included in the Proxy Statement relating to the Registrant's Annual Meeting of Shareholders to be held on April 26, 1994 (the \"Proxy Statement\"), filed by the Registrant with the Securities and Exchange Commission: with respect to the directors of the Registrant, the section captioned \"Election of Directors (Matter No. 1); General.\" Information regarding executive offices of the Registrant is presented in Part I, Item 4A of this Form 10-K.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference is the information included in the Proxy Statement under the headings \"Election of Directors (Matter No. 1); Compensation Paid to Executive Officers.\" \"Election of Directors (Matter No. 1); Executive Employment Agreements\" and \"Election of Directors (Matter No. 1); Compensation Committee Interlocks and Insider Participation.\"\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference is the following information included in the Proxy Statement: (1) with respect to shares owned by certain beneficial owners, the section captioned \"General; Principal Shareholders\" and (2) with respect to shares owned by directors and executive officers, the section captioned \"Election of Directors (Matter No. 1); Security Ownership of Management.\"\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference is the information included in the Proxy Statement under the heading \"Election of Directors (Matter No. 1); Certain Transactions.\"\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this report:\nA.1. Financial Statements (included under Item 8)\n(a) Meridian Bancorp, Inc. and Subsidiaries\n- Management's Statement of Responsibility for Financial Information - Consolidated Balance Sheets - Consolidated Statements of Income - Consolidated Statements of Changes in Shareholders' Equity - Consolidated Statements of Cash Flows - Notes to Consolidated Financial Statements - Opinion of Independent Auditors\n2. All financial schedules are omitted because they are not applicable, the data are not significant or the required information is shown in the Annual Report. (The information that would be shown in Meridian Bancorp, Inc.'s (Parent Company Only) Statements of Changes in Shareholders' Equity is identical to the information supplied in the Consolidated Statements of Changes in Shareholders' Equity which appears herein.)\n3. Exhibits (numbered as in Item 601 of Regulation S-K)\n(3.1) Articles of Incorporation of Meridian Bancorp, Inc., as amended, incorporated herein by reference to Exhibit 3.1 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1988.\n(3.2) By-laws of Meridian Bancorp, Inc., as amended, incorporated herein by reference to Exhibit 3.2 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.\n(4) Agreement to furnish instruments defining the rights of holders of long-term debt of Meridian Bancorp, Inc. and its consolidated subsidiaries, incorporated herein by reference to Exhibit 4 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.\n(9) Voting Trust Agreement (none).\n(10.1) Meridian Bancorp, Inc. Executive Annual Incentive Plan, as amended, incorporated herein by reference to Exhibit 10.1 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.2) Meridian Bancorp, Inc. Retirement Restoration Plan, as amended, incorporated herein by reference to Exhibit 10.2 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.3) Meridian Bancorp, Inc. Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.3 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.4) Meridian Bancorp, Inc. Stock Appreciation Rights Plan, incorporated herein by reference to Exhibit 10.4 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992.*\n(10.5) Meridian Bancorp, Inc. Directors' Deferred Compensation Plan dated July 1, 1983, incorporated herein by reference to Exhibit 10.8 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.6) Form of Deferred Compensation Agreements entered into on January 12, 1987 between Meridian Bancorp, Inc. and Samuel A. McCullough, incorporated herein by reference to Exhibit 10.6 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.7) Form of Directors' Deferred Compensation Agreement, incorporated herein by reference to Exhibit 10.7 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.8) Termination Agreement between Meridian Bancorp, Inc. and Samuel A. McCullough dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.8 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.9) Termination Agreement between Meridian Bancorp, Inc. and Ezekiel S. Ketchum dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.9 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.10) Termination Agreement between Meridian Bancorp, Inc. and Russell J. Kunkel dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.11 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.11) Termination Agreement between Meridian Bancorp, Inc. and David E. Sparks dated as of January 23, 1990, incorporated herein by reference to Exhibit 10.22 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.12) Meridian Bancorp, Inc. Supplemental Salary Reduction Plan, as amended, incorporated herein by reference to Exhibit 10.14 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.13) Meridian Bancorp, Inc. Supplemental Executive Retirement Plan, incorporated herein by reference to Exhibit 10.15 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.14) Meridian Bancorp, Inc. Executive Intermediate Performance Plan adopted January 1, 1990, incorporated herein by reference to Exhibit 10.23 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.15) Rights Agreement dated as of July 25, 1989 between Meridian Bancorp, Inc. and Meridian Trust Company, incorporated by reference to Exhibit 4 of the Current Report on Form 8-K of the Registrant dated August 11, 1989.\n(10.16) Lease of The First National Bank of Allentown building dated August 6, 1984, as amended by First Amendment to Lease dated September 25, 1984, incorporated herein by reference to Exhibit 10.9 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.\n(10.17) Purchase and Assumption Agreement dated October 13, 1989 between Resolution Trust Corporation, Receiver of Hill Financial Savings Association and Meridian Financial Savings Association, F.A., incorporated by reference to Exhibit 1 of the Current Report on Form 8-K of the Registrant dated October 27, 1989.\n(10.18) Preferred Stock Purchase Agreement, dated August 23, 1991, among Meridian Bank, American Title Insurance Company and First Title Insurance Company, incorporated herein by reference to Exhibit 2.2 of the Current Report on Form 8-K of the Registrant dated August 23, 1991.\n(10.19) Agreement, dated as of March 30, 1993, between Commonwealth Bancshares Corporation and the Registrant, incorporated by reference to Exhibit 2.1 to Registration Statement No. 33-65780 on Form S-4 of the Registrant.\n(11) Statement regarding Computation of Per Share Earnings (included herein).\n(12) Statement regarding Computation of Ratios (not applicable).\n(18) Letter regarding Change in Accounting Principles (not applicable).\n(19) Previously Unfiled Documents (none).\n(21) List of Subsidiaries of the Registrant (included herein).\n(22) Published Report Regarding Matters Submitted to a Vote of Security Holders (none).\n(23) Consent of KPMG Peat Marwick (included herein).\n(24) Power of Attorney (none).\n(28) Information from reports furnished to state insurance regulatory authorities (not applicable).\n(99) Additional Exhibits (none).\n________________________ *Denotes compensatory plan or arrangement.\nB.1 Reports on Form 8-K.\nOn November 14, 1993, the Registrant filed an amendment to a Current Report on Form 8-K dated August 31, 1993 for the purpose of filing under Item 7 of the Current Report the following financial statements relating to the Registrant's acquisition of Commonwealth Bancshares Corporation:\n1. Consolidated Statements of Condition as of December 31, 1992 and 1991, and the Consolidated Statements of Income, Consolidated Statements of Changes in Shareholders' Equity and Consolidated Statements of Cash Flows for the years ended December 31, 1992, 1991 and 1990 of Commonwealth Bancshares Corporation, and the related Notes to Consolidated Financial Statements.\n2. Unaudited Consolidated Statement of Condition as of June 30, 1993, the Unaudited Consolidated Statements of Income for the three-month and six- month periods ended June 30, 1993 and 1992, and the Unaudited Consolidated Statements of Cash Flows for the six-month periods ended June 30, 1993 and 1992 of Commonwealth Bancshares Corporation, and the related Notes to Unaudited Consolidated Financial Statements.\n3. Pro forma financial statements of the Registrant and Commonwealth Bancshares Corporation.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMERIDIAN BANCORP, INC. (Registrant)\n/s/ Samuel A. McCullough Samuel A. McCullough, Chairman and Chief Executive Officer\nDate: March 22, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSignature Title Date\n/s/ Samuel A. McCullough Chairman, Chief March 22, 1994 Samuel A. McCullough Executive Officer and Director (Principal Executive Officer)\n/s/ David E. Sparks Vice Chairman, March 22, 1994 David E. Sparks Chief Financial Officer and Director (Principal Financial Officer)\n/s/ Michael J. Mizak, Jr. Senior Vice March 22, 1994 Michael J. Mizak, Jr. President and Controller (Principal Accounting Officer)\n/s/ Delight E. Breidegam, Jr. Director March 22, 1994 DeLight E. Breidegam, Jr.\n/s/ Thomas F. Burke, Jr. Director March 22, 1994 Thomas F. Burke, Jr.\n/s/ Robert W. Cardy Director March 22, 1994 Robert W. Cardy\n/s/ Harry Corless Director March 22, 1994 Harry Corless\n/s/ William D. Davis Director March 22, 1994 William D. Davis\n_____________________________ Director March 22, 1994 Julius W. Erving\n/s/ Fred D. Hafer Director March 22, 1994 Fred D. Hafer\n/s/ Joseph H. Jones Director March 22, 1994 Joseph H. Jones\n_________________________ Director March 22, 1994 Lawrence C. Karlson\n/s/ Ezekiel S. Ketchum Director March 22, 1994 Ezekiel S. Ketchum\n/s/ Sidney D. Kline, Jr. Director March 22, 1994 Sidney D. Kline, Jr.\n/s/ George W. Leighow Director March 22, 1994 George W. Leighow\n/s/ Joseph F. Paquette, Jr. Director March 22, 1994 Joseph F. Paquette, Jr.\n/s/ Daniel H. Polett Director March 22, 1994 Daniel H. Polett\n_____________________________ Director March 22, 1994 Lawrence R. Pugh\n/s/ Paul R. Roedel Director March 22, 1994 Paul R. Roedel\n/s/ Wilmer R. Schultz Director March 22, 1994 Wilmer R. Schultz\n/s/ Robert lB. Seidel Director March 22, 1994 Robert B. Seidel\n/s/ Judith M. von Seldeneck Director March 22, 1994 Judith M. von Seldeneck\n_____________________________ Director March 22, 1994 George Strawbridge, Jr.\n/s/ Anita A. Summers Director March 22, 1994 Anita A. Summers\n/s/ Earle A. Wootton Director March 22, 1994 Earle A. Wootton\nEXHIBIT INDEX\nPage Number Sequentially Numbered Number Description Original - ------ ----------- ------------\n(3.1) Articles of Incorporation of Meridian Bancorp, Inc., as amended, incorporated herein by reference to Exhibit 3.1 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1988.\n(3.2) By-laws of Meridian Bancorp, Inc., as amended, incorporated herein by reference to Exhibit 3.2 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.\n(4) Agreement to furnish instruments defining the rights of holders of long- term debt of Meridian Bancorp, Inc. and its consolidated subsidiaries, incorporated herein by reference to Exhibit 4 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.\n(9) Voting Trust Agreement (none).\n(10.1) Meridian Bancorp, Inc. Executive Annual Incentive Plan, as amended, incorporated herein by reference to Exhibit 10.1 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.2) Meridian Bancorp, Inc. Retirement Restoration Plan, as amended, incorporated herein by reference to Exhibit 10.2 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.3) Meridian Bancorp, Inc. Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.3 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.4) Meridian Bancorp, Inc. Stock Appreciation Rights Plan, incorporated herein by reference to Exhibit 10.4 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1992.*\n(10.5) Meridian Bancorp, Inc. Directors' Deferred Compensation Plan dated July 1, 1983, incorporated herein by reference to Exhibit 10.8 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.6) Form of Deferred Compensation Agreements entered into on January 12, 1987 between Meridian Bancorp, Inc. and Samuel A. McCullough, incorporated herein by reference to Exhibit 10.6 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.7) Form of Directors' Deferred Compensation Agreement, incorporated herein by reference to Exhibit 10.7 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.8) Termination Agreement between Meridian Bancorp, Inc. and Samuel A. McCullough dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.8 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.9) Termination Agreement between Meridian Bancorp, Inc. and Ezekiel S. Ketchum dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.9 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.10) Termination Agreement between Meridian Bancorp, Inc. and Russell J. Kunkel dated as of July 1, 1986, incorporated herein by reference to Exhibit 10.11 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.11) Termination Agreement between Meridian Bancorp, Inc. and David E. Sparks dated as of January 23, 1990, incorporated herein by reference to Exhibit 10.22 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.12) Meridian Bancorp, Inc. Supplemental Salary Reduction Plan, as amended, incorporated herein by reference to Exhibit 10.14 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.13) Meridian Bancorp, Inc. Supplemental Executive Retirement Plan, incorporated herein by reference to Exhibit 10.15 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1991.*\n(10.14) Meridian Bancorp, Inc. Executive Intermediate Performance Plan adopted January 1, 1990, incorporated herein by reference to Exhibit 10.23 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.*\n(10.15) Rights Agreement dated as of July 25, 1989 between Meridian Bancorp, Inc. and Meridian Trust Company, incorporated by reference to Exhibit 4 of the Current Report on Form 8-K of the Registrant dated August 11, 1989.\n(10.16) Lease of The First National Bank of Allentown building dated August 6, 1984, as amended by First Amendment to Lease dated September 25, 1984, incorporated herein by reference to Exhibit 10.9 of the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1990.\n(10.17) Purchase and Assumption Agreement dated October 13, 1989 between Resolution Trust Corporation, Receiver of Hill Financial Savings Association and Meridian Financial Savings Association, F.A., incorporated by reference to Exhibit 1 of the Current Report on Form 8-K of the Registrant dated October 27, 1989.\n(10.18) Preferred Stock Purchase Agreement, dated August 23, 1991, among Meridian Bank, American Title Insurance Company and First Title Insurance Company, incorporated herein by reference to Exhibit 2.2 of the Current Report on Form 8-K of the Registrant dated August 23, 1991.\n(10.19) Agreement, dated as of March 30, 1993, between Commonwealth Bancshares Corporation and the Registrant, incorporated by reference to Exhibit 2.1 to Registration Statement No. 33-65780 on Form S-4 of the Registrant.\n(11) Statement regarding Computation of Per Share Earnings (included herein).\n(12) Statement regarding Computation of Ratios (not applicable).\n(18) Letter regarding Change in Accounting Principles (not applicable).\n(19) Previously Unfiled Documents (none).\n(21) List of Subsidiaries of the Registrant (included herein).\n(22) Published Report Regarding Matters Submitted to a Vote of Security Holders (none).\n(23) Consent of KPMG Peat Marwick (included herein).\n(24) Power of Attorney (none).\n(28) Information from reports furnished to state insurance regulatory authorities (not applicable).\n(99) Additional Exhibits (none). /TABLE\nWORD PERFECT SYSTEM\nLong Document Name: FORM 10-K/MERIDIAN BANCORP, INC. System Document Name: C:\\DMS\\RDG\\WJR\\0003006.WP Document Location: Reading\nAdditional Information:\nscanned and converted from syntrex/FORM 10-K/MERIDIAN BANCORP, INC.\nDO YOU WANT LINE NUMBERS: ____ yes ____ no\nRETURN DOCUMENT IN: ____ draft ____ final\nLINE SPACING: ____ same; ____ 1.0; ____ 1.5; ____ 2.0\nNOTE(S) TO NEXT WORD PROCESSING SPECIALIST:\nEDGAR DOCUMENT - DO NOT USE TABLES OR PARALLEL COLUMNS\nOrigination Date: 3-16-94\nAuthor's Initials: wjr/dws\nLast WPD Specialist: nb/sm/ems&laz/ems/laz/ems/ems/ems\nLast Revision Date: 3-17/3-18/3-21/3-21-94/3-22/3-23/3-23\nParagraph Outline: 1 = 2 = 3 = 4 = 5 = 6 = 7 = 8 ="},"word_count":{"kind":"number","value":30483,"string":"30,483"},"character_count":{"kind":"number","value":201128,"string":"201,128"}}},{"rowIdx":279,"cells":{"filename":{"kind":"string","value":"40211_1993.txt"},"id":{"kind":"string","value":"40211_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"40211"},"text":{"kind":"string","value":"Item 1. Business\nGATX Corporation is a holding company whose subsidiaries engage in the leasing and management of railroad tank cars and specialized freight cars; provide equipment and capital asset financing and related services; own and operate tank storage terminals, pipelines and related facilities; engage in Great Lakes shipping; and provide distribution and logistics support services, warehousing facilities, and related real estate services. Information concerning financial data of business segments and the basis for grouping products or services is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993 on page 27 and pages 32 through 35, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nIndustry Segments\nRailcar Leasing and Management\nThe Railcar Leasing and Management segment (Transportation) is principally engaged in leasing specialized railcars, primarily tank cars, under full service leases. As of December 31, 1993, its fleet consisted of approximately 55,800 railcars, including 48,000 tank cars and 7,800 specialized freight cars, primarily Airslide covered hopper cars and plastic pellet cars. Transportation has upgraded its fleet over time by adding new larger capacity cars and retiring older, smaller capacity cars. Transportation's railcars have a useful life of approximately 30 to 33 years. The average age of the railcars in Transportation's fleet is approximately 15 years.\nThe following table sets forth the approximate tank car fleet capacity of Transportation as of the end of each of the years indicated and the number of cars of all types added to Transportation's fleet during such years:\nTransportation's customers use its railcars to ship over 700 different commodities, primarily chemicals, petroleum, food products and minerals. For 1993, approximately 55% of railcar leasing revenue was attributable to shipments of chemical products, 21% to petroleum products, 18% to food products and 6% to other products. Many of these products require cars with special features; Transportation offers a wide variety of sizes and types of cars to meet these needs. Transportation leases railcars to over 700 customers, including major chemical, oil, food and agricultural companies. No single customer accounts for more than 6% of total railcar leasing revenue.\nTransportation typically leases new equipment to its customers for a term of five years or longer, whereas renewals or leases of used cars are typically for periods ranging from less than a year to seven years with an average lease term of about three years. The utilization rate of Transportation's railcars as of December 31, 1993 was approximately 93%.\nUnder its full service leases, Transportation maintains and services its railcars, pays ad valorem taxes, and provides many ancillary services. Through its Car Status Service System, for example, the company provides customers with timely information about the location and readiness of their leased cars to enhance and maximize the utilization of this equipment. Transportation also maintains a network of service centers consisting of four major service centers and 23 mobile trucks in 16 locations. Transportation also utilizes independent third-party repair shops.\nTransportation purchases most of its new railcars from Trinity Industries, Inc. (Trinity), a Dallas-based metal products manufacturer, under a contract entered into in 1984 and extended from time to time thereafter, most recently in 1992. Transportation anticipates that through this contract it will continue to be able to satisfy its customers' new car lease requirements. Transportation's engineering staff provides Trinity with design criteria and equipment specifications, and works with Trinity's engineers to develop new technology where needed in order to upgrade or improve car performance or in response to regulatory requirements.\nThe full-service railcar leasing industry is comprised of Transportation, Union Tank Car Company, General Electric Railcar Services Corporation, Shippers Car Line division of ACF Industries, Incorporated, and many smaller companies. Of the approximately 192,000 tank cars owned and leased in the United States at December 31, 1993, Transportation had approximately 48,000. Principal competitive factors include price, service and availability.\nFinancial Services\nGATX Financial Services, through its principal subsidiary, GATX Capital Corporation, provides asset-based financing of transportation and industrial equipment through capital leases, secured equipment loans, and operating leases. GATX Capital also provides related financial services which include the arrangement of lease transactions for investment by other lessors and the management of lease portfolios for third parties. In these underwriting and management activities, GATX Capital seeks fee income and residual participation income. In addition to its San Francisco headquarters, GATX Capital has offices in six foreign countries.\nThe financial services industry is both crowded and efficient. GATX Capital is one of the larger non-bank capital services companies. Capital competes with captive leasing companies, leasing subsidiaries of commercial banks, independent leasing companies, lease underwriters and brokers, investment bankers, and also with the manufacturers of equipment. Financing companies compete on the basis of service and effective rates.\nGATX Capital participates in selected areas where it believes the application of its strengths can result in above-market returns in exchange for assuming appropriate levels of risk. GATX Capital has developed a portfolio of assets diversified across industries and equipment classifications, the largest of which include air and rail. At December 31, 1993, GATX Capital had approximately 750 financing contracts with 500 customers, aggregating $1.3 billion of investments before reserves. Of this amount, 47% consisted of investments associated with commercial jet aircraft, 15% railroad equipment, 8% real estate, 8% golf courses, 7% warehouse and production equipment, 6% marine equipment and 9% other equipment.\nTerminals and Pipelines\nGATX Terminals Corporation (Terminals) is engaged in the storage, handling and intermodal transfer of petroleum and chemical commodities at key points in the bulk liquid distribution chain. All of its terminals are located near major distribution and transportation points and most are capable of receiving and shipping bulk liquids by ship, rail, barge and truck. Many of the terminals are also linked with major interstate pipelines. In addition to storing, handling and transferring bulk liquids, Terminals provides blending and testing services at most of its facilities. Terminals also owns or holds interests in four refined product pipeline systems. As of December 31, 1993, Terminals owned and operated 27 terminals in 14 states, nine of which are associated with Terminals' pipeline interests, and eight facilities in the United Kingdom; Terminals also had joint venture interests in 12 international facilities.\nAs of December 31, 1993, Terminals had a total storage capacity of 71 million barrels. This includes 53 million barrels of bulk liquid storage capacity in the United States, 6 million barrels in the United Kingdom, and an equity interest in another 12 million barrels of storage capacity in Europe and the Far East. Terminals' smallest bulk liquid facility has a storage capacity of 100,000 barrels while its largest facility, located in Pasadena, Texas, has a capacity of over 12 million barrels. During 1993, Terminals handled approximately 635 million barrels of product through its wholly-owned bulk liquid storage facilities, with capacity utilization of 92% at the end of 1993.\nFor 1993, 77% of Terminals' revenue was derived from petroleum products and 20% from a variety of chemical products. Demand for Terminals' facilities is dependent in part upon demand for petroleum and chemical products and is also affected by refinery output, foreign imports, and the expansion of its customers into new geographical markets.\nTerminals serves nearly 200 customers, including major oil and chemical companies as well as trading firms and larger independent refiners. No single customer accounts for more than 7% of Terminals' revenue. Customer service contracts are both short term and long term.\nTerminals along with two Dutch companies, Paktank N.V. and Van Ommeren N.V., are the three major international public terminalling companies. The domestic public terminalling industry consists of Terminals, Paktank Corporation, International-Matex Tank Terminals, and many smaller independent terminalling companies. In addition to public terminalling companies, oil and chemical companies, which generally do not make their storage facilities available to others, also have significant storage capacity in their own private facilities. Terminals' pipelines compete with rail, trucks and other pipelines for movement of liquid petroleum products. Principal competitive factors include price, location relative to distribution facilities, and service.\nGreat Lakes Shipping\nAmerican Steamship Company (ASC), with the largest carrying capacity of the domestic Great Lakes vessel fleets, provides modern and efficient waterborne transportation of dry bulk materials to the integrated steel, electric utility and construction industries. ASC's fleet is entirely comprised of self- unloading vessels which do not require any shoreside assistance to discharge cargo. ASC's eleven vessels range in size from 635 feet to 1,000 feet, transport cargoes from 17,000 net tons up to 70,000 net tons depending on vessel size, and can unload at speeds from 2,800 net tons per hour up to 10,000 net tons per hour. Because the Great Lakes are fresh water, Great Lakes vessels are not subject to the severe rusting condition typical of salt water vessels. As a result, ASC's vessels have expected lives of 50 to 75 years.\nIn 1993, ASC carried 24.4 million tons of cargo. The primary materials ASC transported were iron ore, coal and limestone aggregates. Other commodities transported include sand, salt, potash, gypsum, marble chips and slag. ASC competes with three other U.S. flag Great Lakes commercial fleets, which include U.S.S. Great Lakes Fleet, Inc., Columbia Transportation, and Interlake Steamship, and with all steel companies which operate captive fleets. Great Lakes shipping is the only major activity of GATX which consumes substantial quantities of petroleum products; fuel for these operations is presently in adequate supply. Competition is based primarily on service and price. ASC is headquartered in Buffalo, New York, with one regional office. No single customer accounts for more than 21% of ASC's revenue.\nLogistics and Warehousing\nGATX Logistics, Inc. (Logistics) is the largest third-party provider in the United States of distribution and logistics support services, warehousing facilities, and related real estate services. Logistics operates 119 facilities and approximately 22 million square feet of warehousing space in North America with utilization of 94 percent at the end of 1993. Value-adding services are strategically the most important benefit GATX Logistics provides. Examples of these services are logistics planning, information systems, just-in-time delivery systems, packaging, sub-assembly, and returns management.\nGATX Logistics serves about 750 customers, many of which are Fortune 1000-type companies. Most customers are manufacturers, but the customer base also includes retailers. In the warehousing sector, GATX Logistics competes primarily with in-house or private operations and with other national operators as well as multi-regional and local operators. In providing transportation and logistics services, GATX Logistics competes with the major trucking companies and providers of specialized distribution services.\nGATX Logistics' revenue source by industry served during 1993 was 30% consumer products, 20% grocery, 11% farm and construction equipment, 10% motor vehicle parts and components, 5% major appliances, 5% health care, 4% electronics and 15% other. No single customer accounts for more than 8% of Logistics' revenue.\nTrademarks, Patents and Research Activities\nPatents, trademarks, licenses, and research and development activities are not material to these businesses taken as a whole.\nSeasonal Nature of Business\nGreat Lakes shipping is seasonal due to the effects of winter weather conditions. However, seasonality is not considered significant to the operations of GATX and its subsidiaries taken as a whole.\nCustomer Base\nGATX and its subsidiaries are not dependent upon a single customer or a few customers. The loss of any one customer would not have a material adverse effect on any segment or GATX as a whole.\nEmployees\nGATX and its subsidiaries have approximately 5,500 active employees, of whom 25% are hourly employees covered by union contracts.\nEnvironmental Matters\nCertain of GATX's operations present potential environmental risks principally through the transportation or storage of various commodities. Recognizing that some risk to the environment is intrinsic to its operations, GATX is committed to protecting the environment, as well as complying with applicable environmental protection laws and regulations. GATX, as well as its competitors, is subject to extensive regulation under federal, state and local environmental laws which have the effect of increasing the costs and liabilities associated with the conduct of its operations. In addition, GATX's foreign operations are subject to environmental regulations in effect in each respective jurisdiction.\nGATX's policy is to monitor and actively address environmental concerns in a responsible manner. GATX has received notices from the U.S. Environmental Protection Agency (EPA) that it is a potentially responsible party (PRP) for study and clean-up costs at 11 sites under the requirements of the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (Superfund). Under Superfund and comparable state laws, GATX may be required to share in the cost to clean-up various contaminated sites identified by the EPA and other agencies. In all but one instance, GATX is one of several financially responsible PRPs and has been identified as contributing only a small percentage of the contamination at each of the sites. Due to various factors such as the required level of remediation and participation in clean-up efforts by others, GATX's total clean-up costs at these sites cannot be predicted with certainty; however, GATX's best estimates for remediation and restoration of these sites have been determined and are included in its environmental reserves.\nFuture costs of environmental compliance are indeterminable due to unknowns such as the magnitude of possible contamination, the timing and extent of the corrective actions that may be required, the determination of the company's liability in proportion to other responsible parties, and the extent to which such costs are recoverable from third parties including insurers. Also, GATX may incur additional costs relating to facilities and sites where past operations followed practices and procedures that were considered acceptable at the time but in the future may require investigation and/or remedial work to ensure adequate protection to the environment under current standards. If future laws and regulations contain more stringent requirements than presently anticipated, expenditures may be higher than the estimates, forecasts, and assessments of potential environmental costs provided below. However, these costs are expected to be at least equal to the current level of expenditures. In addition, GATX has provided indemnities for environmental issues to the buyers of two divested companies for which GATX believes it has adequate reserves.\nGATX's environmental reserve at the end of 1993 was $81 million and reflects GATX's best estimate of the cost to remediate its environmental conditions. Additions to the reserve were $17 million in both 1993 and 1992. Expenditures charged to the reserve amounted to $10 million and $12 million in 1993 and 1992, respectively.\nIn 1993, GATX made capital expenditures of $18 million for environmental and regulatory compliance compared to $16 million in 1992. These projects included marine vapor recovery, discharge prevention compliance, impervious dikes and tank car cleaning systems. Environmental projects authorized or currently under consideration would require capital expenditures of approximately $25 million in 1994. It is anticipated that GATX will make annual expenditures at a similar level over the next five years for regulatory and environmental requirements.\nItem 2.\n\n\nItem 2. Properties\nInformation regarding the location and general character of certain properties of GATX is included in Item 1, Business, of this document. The major portion of Terminals' land is owned; the balance is leased. Most of the warehouses operated by GATX Logistics are leased; the others are managed for third parties.\nItem 3.\nItem 3. Legal Proceedings\nA railcar owned by Transportation was involved in a derailment near Dunsmuir, California in July 1991 that resulted in a spill of metam sodium into the Sacramento River. Various lawsuits seeking damages in unspecified amounts have been filed against General American Transportation Corporation (GATC), or an affiliated company, most of which have been consolidated in the Superior Court of the State of California for the City and County of San Francisco (Nos. 2617 and 2620). GATC has now been dismissed by the class plaintiffs in those cases but remains in the cases with respect to the plaintiffs who have opted out of the class and with respect to indemnity and contribution claims. There is one other case seeking recovery for response costs and natural resource damages: State of California, et al, vs. Southern Pacific, et al, filed in the Eastern District of California (CIV-S-92 1117). All other actions have been consolidated with these two cases. GATC also has been named as a potentially responsible party by the State of California with respect to the assessment and remediation of possible damages to natural resources which\nclaim has also been consolidated in the suit in the Eastern District of California. GATC has entered into provisional settlement agreements with the United States of America, the state of California, Southern Pacific and certain other defendents settling all material claims arising out of the above incident in an amount not material to GATC. Such settlement, however, is conditional on further court action. Further, it is the opinion of management that if damages are assessed and taking into consideration the probable insurance recovery, this matter will not have a material effect on GATX's consolidated financial position or results of operations.\nVarious lawsuits have been filed in the Superior Court for the State of California and served upon Terminals, Calnev Pipe Line Company, or another GATX subsidiary seeking an unspecified amount of damages arising out of the May 1989 explosion in San Bernardino, California. Those suits, all of which were filed in the County of San Bernardino unless otherwise indicated, are: Aguilar, et al, v. Calnev Pipe Line Company, et al, filed February 1990 in the County of Los Angeles (No. 0751026); Alba, et al, v. Southern Pacific Railroad Co., et al, filed November 1989 (No. 252842); Terry, et al, v. Southern Pacific Transportation Corporation, et al, filed December 1989 (No. 253603) and settled February 1994; Terry, et al, v. Southern Pacific, et al, filed December 1989 (No. 253604); Charles, et al, v. Calnev Pipe Line, Inc., et al, filed May 1990 (No. 256269); Raman, et al, v. Southern Pacific Railroad Company, et al, filed May 1990 (No. 256181) and settled October 1993; Abrego, et al, v. Southern Pacific Transportation Corporation, et al, filed May 1990 in the County of Los Angeles (No. BC 000947); Glaspie, et al, v. Southern Pacific Transportation, et al, filed May 1990 in the County of Los Angeles (No. BC002047); Jackson, et al, v. City of San Bernardino, et al, filed May 1990 (No. 256172) and settled February 1993; Burney, et al, v. Southern Pacific, et al, filed May 1990 in the County of Los Angeles (BC000876); Hawkins, et al, v. Southern Pacific, et al, filed May 1990 in the County of Los Angeles (BC000825) and since dismissed as to all GATX subsidiaries; Ledbetter, et al, v. City of San Bernardino, et al, filed May 1990 (No. 256173); Mary Washington v. Southern Pacific, et al, filed May 1990 (No. 256346); Stewart, et al, v. Southern Pacific Railroad Co., et al, filed May 1990 (No. 256464); Yost, et al, v. Southern Pacific Railroad, et al, filed June 1989 (No. 250308) and dismissed January 1993; Riley, et al, v. Lake Minerals Corp., et al, filed May 1990 (No. 256163) and settled September 1993; Pearson v. Calnev Pipe Line Company, et al, filed May 1990 in the County of San Bernardino (No. 256206); Pollack v. Southern Pacific Transportation, et al, filed May 1992 (No. 271247); Davis v. Calnev Pipe Line Company, et al, filed May 1990 (No. 256207); J. Roberts, et al, v. Southern Pacific Transportation, et al, filed November 1992 (No. 275936); Brooks, et al, v. Southern Pacific, et al, filed May 1990 (No. 256176) and settled February 1994; Goldie, et al, v. Southern Pacific, et al, filed May 1990 and dismissed July 1993, appeal pending; Irby, et al, v. Southern Pacific, et al, (No. 255715) filed April 1990; Esparza, et al, v. Southern Pacific, et al, (No. 256433) filed May 1990 and settled February 1994; Reese, et al, v. Southern Pacific, et al (No. 256434) filed May 1990; Nancy Washington, et al, v. Southern Pacific, et al, (No. 256435) filed May 1990. In addition, GATX is aware of approximately 10 other cases (the majority involving multiple plaintiffs) seeking damages arising out of this incident which have named but not served a subsidiary of GATX or a subsidiary officer. Based upon information known to management, it remains management's opinion that if damages are assessed and taking into consideration probable insurance recovery, the ultimate resolution of the lawsuits arising out of the May 1989 explosion will not have a material effect on GATX's consolidated financial position or results of operations.\nIn October 1991, GATX and five of its senior officers were named as defendants in Searls vs. Glasser, et al, filed in the U.S. District Court for the Northern District of Illinois, a class action filed on behalf of certain purchasers of GATX's common stock alleging violation of the securities laws, common law fraud and negligent misrepresentation in various public statements made by GATX during 1991 concerning 1992 forecasted earnings. Upon the completion of extensive discovery, GATX filed a motion for summary judgment which the court has taken under consideration. GATX believes that it has a strong defense and that the complaint is without merit.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders\nNone.\nExecutive Officers of the Registrant\nPursuant to General Instruction G(3), the following information regarding executive officers is included in Part I in lieu of inclusion in the GATX Proxy Statement:\nOffice Held Name Office Held Since Age\nJames J. Glasser Chairman of the Board, President and Chief Executive Officer 1978 59\nJohn F. Chlebowski, Jr.Vice President, Finance and 1985 48 Chief Financial Officer\nWilliam L. Chambers Vice President, Human Resources 1993 56\nPaul A. Heinen Vice President, General Counsel and Secretary 1981 63\nRalph L. O'Hara Controller 1986 49\nE. Paul Dunn, Jr. Treasurer 1990 40\nOfficers are elected annually by the Board of Directors. Previously, Mr. Chambers was the Senior Vice President of Human Resources and Corporate Relations for Beatrice Company from 1986 to 1990. From 1991 until 1993, Mr. Chambers was engaged in human resource consulting. Previously, Mr. Dunn was Assistant Treasurer of The Hertz Corporation from 1985-1990.\nPART II\nItem 5.\nItem 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nInformation required by this item is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993 on page 59, which is incorporated herein by reference (page reference is to the Annual Report to Shareholders).\nItem 6.\nItem 6. Selected Financial Data\nInformation required by this item is contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993, on pages 60 and 61, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nItem 7.\nItem 7. Management Discussion and Analysis of Financial Condition and Results of Operations\nInformation required by this item is contained in Item 1, Businss, section of this document and in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993, the management discussion and analysis on pages 29, 30, 31, 37, 39, 41 and 42, the financial data of business segments on pages 32 through 35, and the discussion of 1992 and 1991 operations on pages 62 and 63, which is incorporated herein by reference (page references are to the Annual Report to Shareholders).\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of GATX Corporation, included in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993, which is incorporated herein by reference (page references are to the Annual Report to Shareholders):\nStatements of Consolidated Income and Reinvested Earnings -- Years ended December 31, 1993, 1992 and 1991, on page 36. Consolidated Balance Sheets -- December 31, 1993 and 1992, on page 38. Statements of Consolidated Cash Flows -- Years ended December 31, 1993, 1992 and 1991, on page 40. Notes to Consolidated Financial Statements on pages 43 through 58.\nQuarterly results of operations are contained in Exhibit 13, GATX Annual Report to Shareholders for the year ended December 31, 1993 on page 59, which is incorporated herein by reference (page reference is to the Annual Report to Shareholders).\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant\nInformation required by this item regarding directors is contained in sections entitled \"Nominees For Directors\" and \"Additional Information Concerning Nominees\" in the GATX Proxy Statement dated March 11, 1994, which sections are incorporated herein by reference. Information regarding officers is included at the end of Part I.\nItem 11.\nItem 11. Executive Compensation\nInformation required by this item regarding executive compensation is contained in sections entitled \"Compensation of Directors\" and \"Compensation of Executive Officers\" in the GATX Proxy Statement dated March 11, 1994, which sections are incorporated herein by reference.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nInformation required by this item regarding the Company's Common Stock is contained in sections entitled \"Nominees For Directors,\" \"Security Ownership of Management\" and \"Beneficial Ownership of Common Stock\" in the GATX Proxy Statement dated March 11, 1994, which sections are incorporated herein by reference. The following are the only persons known to the Company who beneficially owned as of March 4, 1994 more than 5% of the Company's $3.875 Cumulative Convertible Preferred Stock (\"CCP Stock\"):\nItem 13.\nItem 13. Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14.\nItem 14. Financial Statement Schedules, Reports on Form 8-K and Exhibits.\na) 1. -Financial Statements\nThe following consolidated financial statements of GATX Corporation included in the Annual Report to Shareholders for the year ended December 31, 1993, are filed in response to Item 8:\nStatements of Consolidated Income and Reinvested Earnings -- Years ended December 31, 1993, 1992 and 1991 Consolidated Balance Sheets -- December 31, 1993 and 1992 Statements of Consolidated Cash Flows -- Years ended December 31, 1993, 1992 and 1991 Notes to Consolidated Financial Statements\n2. -Financial Statement Schedules: Page\nSchedule IIICondensed Financial Information of Registrant................ 17 Schedule V Property, Plant and Equipment.............. 21 Schedule VI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment................................ 25 Schedule VIIIValuation and Qualifying Accounts ......... 29 Schedule IX Short-Term Borrowings...................... 30 Schedule X Supplementary Income Statement Information. 31\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and, therefore, have been omitted.\nB) EXHIBIT INDEX\nExhibit Number Exhibit Description Page\n3A. Restated Certificate of Incorporation of GATX Corporation, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n3B. Bylaws of GATX Corporation, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file number 1-2328.\n4A. Rights Agreement dated as of May 15, 1986, as amended and restated as of June 2, 1989, between GATX Corporation and Manufacturers Hanover Trust Company, as Rights Agent, incorporated by reference to Exhibit 4 contained in GATX's Amendment on Form 8 dated July 14, 1989, to its Registration Statement on Form 8-A, file number 1-2328.\n10A. GATX Corporation 1980 Long Term Incentive Compensation Plan, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10B. GATX Corporation 1985 Long Term Incentive Compensation Plan, as amended, and restated as of April 27, 1990, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file No. 1-2328. Amendment to said Plan effective as of April 1, 1991, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10C. Management Incentive Compensation Plan dated January 1, 1993, file number 1-2328, submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n10D. GATX Corporation Deferred Fee Plan for Directors, effective April 1982, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10E. 1984 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated September 1, 1984, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\nEXHIBIT INDEX - CONTINUED\nExhibit Number Exhibit Description Page\n10F. 1985 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated July 1, 1985, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10G. 1987 Executive Deferred Income Plan Participation Agreement between GATX Corporation and participating directors and executive officers dated December 31, 1986, as amended, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328.\n10H. Amendment to Executive Deferred Income Plan Participation Agreements between GATX and certain participating directors and participating executive officers entered into as of January 1, 1990, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 1-2328.\n10I. Retirement Supplement to Executive Deferred Income Plan Participation Agreements entered into as of January 23, 1990, between GATX and certain participating directors incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 1-2328 and between GATX and certain other participating directors incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, file number 1-2328.\n10J. Amendment to Executive Deferred Income Plan Participation Agreements between GATX and participating executive officers entered into as of April 23, 1993. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n10K. Agreement for Continued Employment Following Change of Control or Disposition of a Subsidiary between GATX Corporation and certain executive officers dated as of January 1, 1992, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 1-2328 and between GATX and an additional executive officer dated as of January 1, 1992, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, file number 1-2328.\nEXHIBIT INDEX - CONTINUED\nExhibit Number Exhibit Description Page\n10L. Letter agreement dated March 5, 1986, between GATX Corporation and an executive officer of GATX, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, file number 1-2328.\n10M. Letter agreement dated June 5, 1987, between GATX Corporation and an executive officer of GATX, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, file number 1-2328.\n10N. Director Retirement Plan effective January 1, 1992, incorporated by reference to GATX's Annual Report on Form 10- K for the fiscal year ended December 31, 1992, file number 1- 2328.\n11. Statements regarding computation of net income (loss) per share. 32-33\n12. Statement regarding computation of ratios of earnings to combined fixed charges and preferred stock dividends.34\n13. Annual Report to Shareholders for the year ended December 31, 1993, pages 27-65, with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1993, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n22. Subsidiaries of the Registrant. 35 24. Consent of Independent Auditors. 36 25. Powers of Attorney with respect to the Annual Report on Form 10-K for the fiscal year ended December 31, 1993, file number 1-2328. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n28A. Undertakings to the GATX Corporation 1980 Long Term Incentive Plan, incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1982, file number 1-2328.\n28B. Undertakings to the GATX Corporation Salaried Employees Retirement Savings Plan, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1982, file number 1-2328.\n28C. Undertakings to the GATX Corporation 1985 Long Term Incentive Plan, incorporated by reference to GATX's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, file number 1-2328.\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors GATX Corporation\nWe have audited the consolidated financial statements and related schedules of GATX Corporation and subsidiaries listed in Item 14 (a)(1) and (2) of the Annual Report on Form 10-K of GATX Corporation for the year ended December 31, 1993. These financial statements and related schedules are the responsibility of GATX's management. Our responsibility is to express an opinion on these financial statements and related schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and related schedules. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of GATX Corporation and subsidiaries at December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statements schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects, the information set forth therein.\nAs discussed in the notes to the consolidated financial statements, in 1992 the Company changed its method of accounting for the postretirement benefits other than pensions and income taxes.\nERNST & YOUNG\nChicago, Illinois January 25, 1994\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGATX CORPORATION (Registrant)\n/s/James J. Glasser ------------------------------- James J. Glasser Chairman of the Board, President and Chief Executive Officer March 21, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\n/s/James J. Glasser ---------------------- James J. Glasser Chairman of the Board, President March 21, 1994 and Chief Executive Officer\n/s/John F. Chlebowski, Jr. ------------------------- John F. Chlebowski, Jr. Vice President, Finance and March 21, 1994 Chief Financial Officer\n/s/Ralph L. O'Hara ---------------------- Ralph L. O'Hara Controller and March 21, 1994 Principal Accounting Officer\nWeston R. Christopherson Director Franklin A. Cole Director James W. Cozad Director By /s/Paul A. Heinen Robert J. Day Director (Paul A. Heinen, James L. Dutt Director Attorney-in-Fact) Deborah M. Fretz Director Richard A. Giesen Director Charles Marshall Director Michael E. Murphy Director Marcia T. Thompson Director Date: March 21, 1994\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nGATX CORPORATION (PARENT COMPANY)\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONT'D)\nGATX CORPORATION (PARENT COMPANY)\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONT'D)\nGATX CORPORATION (PARENT COMPANY)\nSee notes to Schedule V on page 24.\nSee notes to Schedule V on page 24.\nSee notes to Schedule V on page 24.\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT (CONT'D)\nGATX CORPORATION AND SUBSIDIARIES\nNote A - The estimated useful lives of depreciable assets are as follows:\nRailcars 20 - 33 years Great Lakes vessels 30 - 40 years Buildings, leasehold improvements, storage tanks and pipelines 5 - 45 years Machinery and related equipment 3 - 20 years Operating lease investments 3 - 40 years\nNote B - Represents primarily the sale leaseback of certain railcar additions.\nNote C - Represents adjustments associated with transfers and reclassifications of certain facilities and other assets, and foreign currency translation adjustments.\nNote D - Represents adjustments associated with transfers and reclassifications of operating lease assets and in 1993 represents primarily the sale leaseback of a rail equipment portfolio.\nNote E - Primarily represents expiration of capital lease related to one of the vessels.\nNote F - Represents primarily asset values assigned to GATX Logistics' acquisitions.\nSee notes to Schedule VI on page 28.\nSee notes to Schedule VI on page 28.\nSee notes to Schedule VI on page 28.\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (CONT'D)\nGATX CORPORATION AND SUBSIDIARIES\nNote A - In 1993, represents $2.8 million of accumulated depreciation related to the sale leaseback of railcars and $3.5 million related to the early disposal of railcars, offset by $.9 million of reserves for the cost of scrapped railcars. In 1992, represents $6.0 million of accumulated depreciation related to the sale leaseback of railcars and $1.2 million for an early disposal, offset by $5.5 million of reserves for the cost of scrapped railcars. In 1991, represents $3.0 million of accumulated depreciation related to the sale leaseback of railcars increased by a $.9 million loss on the cost of scrapped railcars.\nNote B - Represents adjustments associated with transfers and reclassifications of certain facilities and other assets, and foreign currency translation adjustments.\nNote C - Represents adjustments associated with transfers and reclassifications of operating lease assets."},"word_count":{"kind":"number","value":6307,"string":"6,307"},"character_count":{"kind":"number","value":41577,"string":"41,577"}}},{"rowIdx":280,"cells":{"filename":{"kind":"string","value":"27673_1993.txt"},"id":{"kind":"string","value":"27673_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"27673"},"text":{"kind":"string","value":"ITEM 1. BUSINESS.\nTHE COMPANY\nThe principal business of John Deere Capital Corporation (Capital Corporation) is the purchasing and financing of retail installment sales and loan contracts (retail notes) from the equipment sales branches in the United States operated by Deere & Company and its wholly-owned subsidiaries (collectively called John Deere). These notes are acquired by the sales branches through John Deere retail dealers in the United States and originate in connection with retail sales by dealers of new John Deere agricultural equipment, industrial equipment and lawn and grounds care equipment, as well as used equipment. The Capital Corporation and its subsidiaries also purchase and finance retail notes unrelated to John Deere equipment, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine mortgage service companies (recreational product retail notes). The Capital Corporation and its subsidiaries also lease John Deere equipment to retail customers, finance and service unsecured revolving charge accounts acquired from merchants in the agricultural, lawn and grounds care and marine retail markets, and provide wholesale financing for recreational vehicles and John Deere engine inventories held by dealers of those products.\nThe Capital Corporation and its subsidiaries: Deere Credit, Inc., Farm Plan Corporation, Deere Credit Services, Inc. and John Deere Receivables, Inc. are collectively called the Company. John Deere Credit Company, a wholly-owned finance holding subsidiary of Deere & Company, is the parent of the Capital Corporation.\nRetail notes, revolving charge accounts, financing leases and wholesale notes receivable are collectively called \"Receivables.\" Receivables and operating leases are collectively called \"Receivables and Leases.\"\nThe Capital Corporation was incorporated under the laws of Delaware and commenced operations in 1958. At January 1, 1994, the Company had 852 full- and part-time employees.\nBUSINESS OF JOHN DEERE\nJohn Deere's operations are categorized into five business segments:\nJohn Deere's worldwide AGRICULTURAL EQUIPMENT segment manufactures and distributes a full range of equipment used in commercial farming -- including tractors; tillage, soil preparation, planting and harvesting machinery; and crop handling equipment.\nJohn Deere's worldwide INDUSTRIAL EQUIPMENT segment manufactures and distributes a broad range of machines used in construction, earthmoving and forestry -- including backhoe loaders; crawler dozers and loaders; four-wheel-drive\nloaders; scrapers; motor graders; excavators; and log skidders. This segment also includes the manufacture and distribution of engines and drivetrain components for the original equipment manufacturer (OEM) market.\nJohn Deere's worldwide LAWN AND GROUNDS CARE EQUIPMENT segment manufactures and distributes equipment for commercial and residential uses - including small tractors for lawn, garden and utility purposes; riding and walk-behind mowers; golf course equipment; utility transport vehicles; snowblowers; and other outdoor power products.\nThe products produced by the equipment segments are marketed primarily through independent retail dealer networks.\nThe CREDIT segment includes the operations of the Company (described herein), the Company's parent, John Deere Credit Company, and John Deere Finance Limited, which primarily purchases and finances retail notes from John Deere's equipment sales branches in Canada.\nThe INSURANCE AND HEALTH CARE segment issues policies in the United States and Canada primarily for: a general line of property and casualty insurance to John Deere and non-Deere dealers and to the general public; group life and group accident and health insurance for employees of participating John Deere dealers; group life and group accident and health insurance for employees of John Deere; life and annuity products to the general public and credit physical damage insurance in connection with certain retail sales of John Deere products financed by the credit subsidiaries. This segment also provides health management programs and related administrative services in the United States to corporate customers and employees of John Deere.\nJohn Deere's total worldwide net sales and revenues in 1993 and 1992, which include net sales of agricultural equipment, industrial equipment and lawn and grounds care equipment and revenues from credit, insurance and health care operations, were as follows: total net sales and revenues, $7.8 billion and $7.0 billion; total sales of equipment, $6.5 billion and $5.7 billion; agricultural equipment sales, $4.1 billion and $3.8 billion; industrial equipment sales, $1.3 billion and $1.0 billion; and lawn and grounds care equipment sales, $1.1 billion and $.9 billion, respectively. John Deere believes that its worldwide sales of agricultural equipment during recent years have been greater than those of any other business enterprise. It also believes that it is an important provider of most of the types of industrial equipment that it markets and a leader in some size ranges. John Deere also believes that it is the largest manufacturer of lawn and garden tractors and provides the broadest line of grounds care equipment in North America.\nJohn Deere's 1993 worldwide income before the effects of special items (accounting changes, restructuring charges and the new United States tax law) was $286 million compared with $37 million in 1992. Additional information concerning the special items is presented in the Deere & Company Annual Report on Form 10-K for the fiscal year ended October 31, 1993. John Deere's improved 1993 results were mainly attributable to North American equipment operations. Sales and production volumes in\nNorth America were higher this year in response to increased retail demand. Price realization also improved in all of John Deere's North American equipment businesses compared with 1992 as sales incentive cost levels were significantly lower. Also, North American productivity continued to improve during 1993. Additionally, income of John Deere's financial services subsidiaries was significantly higher in 1993 compared with 1992. After the effects of restructuring charges, the incremental expenses from the accounting changes and the tax rate change, John Deere's worldwide income in 1993 was $184 million. John Deere incurred a worldwide net loss in 1993 of $921 million after all of the special items, including the cumulative effect of the accounting changes.\nNorth American agricultural economic conditions were generally more favorable in 1993 than in 1992. Although flooding and excessively wet conditions in certain areas of the Midwest and drought conditions in parts of the Southeast resulted in an estimated 31 percent decrease in corn production and a 16 percent decline in soybean production in 1993, United States farm net cash income is expected to achieve a record level in 1993. The lower production caused grain prices to rise above 1992 levels. Livestock producers enjoyed favorable prices and profit margins during 1993 and farmers boosted their cash flow by selling inventories accumulated from record corn and soybean yields in 1992. Additionally, direct government payments to farmers are expected to increase in 1993, aiding farmers most heavily impacted by this year's flooding. Uncertainties over the passage of a new investment tax credit were resolved in 1993 as the anticipated tax credit was not included in the final tax legislation. Consequently, many United States farmers who had delayed making purchases in 1992 bought equipment this year. Sales in Canada were boosted by a special 13-month investment tax credit in effect from December 1992 to December 1993. As a result of these developments, North American retail sales of John Deere agricultural equipment were considerably higher in 1993 compared with last year.\nThe North American general economy continued its slow expansion in 1993. In the United States, housing starts increased about five percent during the year with second-half strength overcoming a very sluggish first half. Real public construction was up slightly from the previous year's level while nonresidential construction was flat. However, the cumulative effects of the rebound in economic activity were felt in 1993, as housing starts were up more than 25 percent from their 1991 level and real public construction was nine percent larger. North American retail sales of industrial and construction machinery for both the industry and John Deere rose significantly in 1993.\nConsumer spending for durable goods rose briskly in 1993, and North American retail sales of John Deere lawn and grounds care equipment increased significantly. Sales were also supported by favorable moisture conditions over most areas throughout the prime selling season. However, dry conditions did emerge in portions of the Southeast and Northeast which impeded some late season buying activity.\nIndustry retail sales of agricultural equipment in overseas markets in general remained relatively weak during 1993. However, overseas retail sales of John Deere agricultural equipment were higher in 1993 than in 1992, reflecting good acceptance of John Deere's new tractors and combines. Despite recessionary conditions prevailing in most European markets and in Japan, overseas retail sales of John Deere lawn and\ngrounds care equipment continued to expand in 1993. Overseas industrial and construction equipment markets were relatively flat in 1993 compared with 1992.\nRELATIONSHIPS OF THE COMPANY WITH JOHN DEERE\nThe operations and results of the Company are affected by its relationships with John Deere, including, among other things, the terms on which the Company acquires Receivables and Leases and borrows funds from John Deere, the reimbursement for waiver and low-rate finance programs from John Deere and the payment to John Deere for various expenses applicable to the Company's operations. In addition, the Capital Corporation and John Deere have joint access to all of the Capital Corporation's bank lines of credit.\nThe Company's acquisition of Receivables and Leases is largely dependent upon the level of retail sales and leases of John Deere products. The level of John Deere retail sales and leases is responsive to a variety of economic, financial, climatic and other factors which influence demand for its products. Since 1986, the Company has also been providing retail sales financing through dealers of certain unrelated manufacturers of recreational vehicles and recreational marine products. The net balance of recreational product retail notes outstanding under these arrangements at October 31, 1993 totaled $804 million.\nThe Company bears all of the credit risk (net of recovery from withholdings from certain John Deere dealers and Farm Plan merchants) associated with its holding of Receivables and Leases, and performs all servicing and collection functions. The Company compensates John Deere for originating retail notes and leases on John Deere products or through John Deere dealers. John Deere is also reimbursed for staff and other administrative services at estimated cost, and for credit lines provided to the Company based on utilization of those lines.\nThe terms of retail notes and the basis on which the Company acquires retail notes from John Deere are governed by agreements with the sales branches, terminable by either the sales branches or the Company on 30 days notice. As provided in these agreements, the Company sets its terms and conditions for purchasing the retail notes from the sales branches. Under these agreements, the sales branches are not obligated to sell retail notes to the Company, and the Company is obligated to purchase retail notes from the sales branches only if the notes comply with the terms and conditions set by the Company.\nThe terms of retail notes and the basis on which the sales branches acquire retail notes from the dealers are governed by agreements with the independent John Deere dealers, terminable at will by either the dealers or the sales branches. In acquiring the retail notes from dealers, the terms and conditions, as set forth in agreements with the dealers, conform with the terms and conditions adopted by the Company in determining the acceptability of retail notes to be purchased from the sales branches. The dealers are not obligated to send retail notes to the sales branches, and the sales branches are not obligated to accept retail notes from the dealers. In practice, retail notes are acquired from dealers only if the terms of the notes and the creditworthiness of the customers are\nacceptable to the Company for purchase of the notes from the sales branches. The Company acts on behalf of both itself and the sales branches in determining the acceptability of the notes and in acquiring acceptable notes from dealers.\nThe terms of leases, and the basis on which the Company enters into such leases with retail customers through John Deere dealers, are governed by agreements between dealers and the Company. Leases are accepted based on the lessees' creditworthiness, the anticipated residual values of the equipment and the intended uses of the equipment.\nDeere & Company has expressed an intention of conducting its business with the Company on such terms that the Company's consolidated ratio of earnings before fixed charges to fixed charges will not be less than 1.05 to 1 for any fiscal quarter. For 1993, the ratio was 1.99 to 1 (excluding the effects of accounting changes) and for 1992, it was 1.74 to 1. For additional information concerning these accounting changes, see note 1 to the consolidated financial statements. This arrangement is not intended to make Deere & Company responsible for the payment of obligations of the Company.\nDESCRIPTION OF RECEIVABLES AND LEASES\nReceivables and Leases arise mainly from the retail sale or lease (including the sale to John Deere dealers for rental to users) of John Deere products, used equipment accepted in trade for them, and equipment of unrelated manufacturers, and also include revolving charge accounts receivable and wholesale notes receivable. The great majority derive from retail sales and leases of agricultural equipment, industrial equipment and lawn and grounds care equipment sold by John Deere dealers. The Company also offers financing to recreational product customers through the secured retail financing of recreational vehicles and recreational marine products. The Company also offers Farm Plan revolving charge accounts which are used primarily by agri-businesses to finance customer purchases, as well as credit cards which are used primarily by retail customers to finance purchases of John Deere lawn and grounds care equipment and marine equipment. Retail notes provide for retention by John Deere or the Company of security interests under certain statutes, including the Uniform Commercial Code or comparable state statutes, certain Federal statutes, and state motor vehicle laws. See notes 1 and 2 to the consolidated financial statements.\nRecreational product retail notes conform to industry standards different from those for John Deere retail notes and often have smaller down payments and longer repayment terms. In addition, the volumes, margins, and collectibility of recreational product retail notes are affected by different economic, marketing and competitive factors and cycles, such as fluctuations in fuel prices and recreational spending patterns, than those affecting retail notes arising from the sale of John Deere equipment. Recreational product retail notes are acquired from more than 1,400 recreational vehicle dealers throughout the United States, representing a variety of manufacturers, and from approximately 900 marine product dealers.\nReceivables and Leases are eligible for acceptance if they conform to prescribed finance and lease plan terms. Guidelines relating to down payments and contract terms\non retail notes and leases are described in note 2 to the consolidated financial statements.\nThe John Deere Credit Revolving Plan is used primarily by retail customers of John Deere dealers to finance purchases of John Deere lawn and grounds care equipment. Additionally, through its Farm Plan credit product, the Company finances revolving charge accounts offered by approximately 2,100 participating agri-businesses in the 48 contiguous states to their retail customers for the purchase of goods and services. Farm Plan account holders consist mainly of farmers purchasing equipment parts and service at implement dealerships. Farm Plan revolving charge accounts are also used by customers patronizing other agribusinesses, including farm supply, feed and seed, parts supply, bulk fuel, building supply and veterinarians. John Deere Marine Finance is used by the Company's marine customers to finance the purchase of marine related products. See notes 1 and 2 to the consolidated financial statements under \"Revolving Charge Accounts Receivable.\"\nThe Company finances recreational vehicle inventories and John Deere engines for approximately 300 dealers. A portion of the wholesale financing provided by the Company is with dealers from whom it also purchases recreational product retail notes. See notes 1 and 2 to the consolidated financial statements under \"Wholesale Receivables.\"\nThe Company requires that theft and physical damage insurance be carried on all equipment leased or securing retail notes. The customer may, at his own expense, have the Company purchase this insurance or obtain it from other sources. Theft and physical damage insurance is also required on wholesale notes and can be purchased through the Company or from other sources. If the customer elects to purchase theft and physical damage insurance through the Company, the Company purchases it from insurance subsidiaries of Deere & Company. Insurance is not required for revolving charge accounts.\nIn some circumstances, Receivables and Leases may be accepted and acquired even though they do not conform in all respects to the established guidelines. Acceptability and servicing of retail notes, wholesale notes and leases, according to the finance plans and retail terms, including any waiver of conformity with such plans and terms, is determined by Company personnel. Officers of the Company are responsible for reviewing the performance of the Company in accepting and collecting retail notes, wholesale notes and leases. The Company normally makes all routine collections, compromises, settlements and repossessions on Receivables and Leases.\nFINANCE RATES ON RETAIL NOTES\nAs of October 31, 1993, approximately 57 percent of the net dollar value of retail notes held by the Company bore a variable finance rate. Recreational product retail notes are primarily fixed-rate notes.\nA portion of the finance income earned by the Company arises from retail sales of John Deere equipment sold in advance of the season of use or in other sales promotions\nby John Deere on which finance charges are waived by John Deere for a period from the date of sale to a specified subsequent date. Some low-rate financing programs are also offered by John Deere. The Company receives compensation from John Deere approximately equal to the normal net finance charge on retail notes for periods during which finance charges have been waived or reduced. The portions of the Company's finance income earned that were received from John Deere on retail notes containing waiver of finance charges or reduced rates was 19 percent in 1993 and 17 percent in 1992.\nRECEIVABLES AND LEASES ACQUIRED AND HELD\nReceivable and Lease acquisitions during the fiscal years ended and amounts held at October 31, 1993 and 1992 were as follows in millions of dollars:\nJohn Deere equipment note acquisitions were slightly lower in the current year due primarily to a larger volume of cash purchases by John Deere customers and a more competitive agricultural financing environment. Lower acquisitions of agricultural and lawn and grounds care equipment notes were partially offset by higher acquisitions of industrial equipment notes. Acquisitions of recreational product retail notes were 20 percent lower in the current year due to a more competitive market for recreational product financing.\nThe Company's business is somewhat seasonal, with overall acquisitions of credit receivables traditionally higher in the second half of the fiscal year than in the first half, and overall collections of credit receivables traditionally somewhat higher in the first six months than in the last half of the fiscal year.\nFrom time to time, the Capital Corporation sells retail notes to other financial institutions and in the public market. The Capital Corporation received net proceeds from such sales of John Deere retail notes of $1.143 billion in 1993 and $683 million in 1992. The net unpaid balance of all retail notes previously sold was $1.394 billion at October 31, 1993 and $688 million at October 31, 1992. For additional information on the terms, conditions, recourse and accounting for such sales, see note 2 to the consolidated financial statements.\nAVERAGE ORIGINAL TERM AND AVERAGE LIFE OF RETAIL NOTES AND LEASES\nThe following table shows the estimated average original term in months (based on dollar amounts) for retail notes and leases acquired by the Company during 1993 and 1992:\nBecause of prepayments, the average actual life of retail notes is considerably shorter than the average original term. The following table shows the estimated average life in months (based on dollar amounts) for John Deere retail notes and leases liquidated in 1993 and 1992:\nDEPOSITS WITHHELD ON RECEIVABLES AND LEASES\nGenerally, the Company has limited recourse against certain John Deere dealers on retail notes and leases and against certain Farm Plan merchants on revolving charge account balances acquired from or through those dealers and merchants. For these John Deere dealers and Farm Plan merchants, separate withholding accounts are maintained by the Company. The total amount of deposits withheld from John Deere dealers and Farm Plan merchants totaled $104.9 million and $100.7 million at October 31, 1993 and 1992, respectively. Of this amount, deposits withheld from Farm Plan merchants totaled $.4 million at October 31, 1993 and $ .8 million at October 31, 1992. Credit losses are charged against these withheld deposits. To the extent that a loss cannot be absorbed by the deposit withheld from the dealer or merchant from which the retail note, lease or Farm Plan account was acquired, it is charged against the Company's allowance for credit losses. Beginning in January 1992, all industrial equipment retail notes have been accepted on a non-recourse basis, and the withholding of dealer deposits on those notes ceased. See note 1 to the consolidated financial statements.\nThe Company does not withhold deposits on recreational product retail notes, credit card receivables, or wholesale notes acquired. However, an\nallowance for credit losses has been established by the Company in an amount considered to be appropriate in relation to the Receivables and Leases outstanding. In addition, for wholesale notes relating to recreational vehicles, there are agreements with the recreational vehicle manufacturers for the repurchase of new inventories held by dealers. For additional information on credit losses and deposits withheld on Receivables and Leases, see note 3 to the consolidated financial statements.\nDELINQUENCIES AND LOSSES\nRETAIL NOTES. The following table shows unpaid installments 60 days or more past due on retail notes held by the Company and the total unpaid balances on the retail notes with such delinquencies, on the basis of retail note terms in effect at the indicated dates, in millions of dollars and as a percentage of retail notes at face value held by the Company at such dates:\nThe following table shows losses on retail notes in millions of dollars (after charges to withheld dealer deposits) and as a percentage of retail notes liquidated:\nThe decrease in losses in 1993 and 1992 related mainly to lower write-offs of recreational product retail notes, primarily as a result of the development and use of more selective credit criteria over the past few years, and lower write-offs of John Deere industrial equipment retail notes. The losses incurred in 1991 related primarily to recreational product retail notes, resulting from recessionary pressures and lower resale values of repossessed equipment. Write-offs of recreational product retail notes totaled $16.9 million in 1993 compared with $24.2 million in 1992 and $33.3 million in 1991.\nREVOLVING CHARGE ACCOUNTS. The following table shows revolving charge account payments 60 days or more past due in millions of dollars and as a percentage of total revolving charge accounts receivable:\nThe following table shows losses on revolving charge accounts in millions of dollars and as a percentage of revolving charge amounts liquidated:\nLosses declined in 1993 and 1992 for both Farm Plan and the John Deere Credit Revolving Plan reflecting improvements in the Company's overall collection procedures and improved economic conditions. The losses incurred in 1991 were due primarily to general recessionary conditions in the economy.\nLEASES. The following table shows finance and operating lease payments 60 days or more past due in millions of dollars and as a percent of the total lease payments receivable:\nThe following table shows losses absorbed by the Company, in millions of dollars and as a percent of total lease proceeds, on terminated financing and operating leases (after charges to withheld dealer deposits). Total lease proceeds include collections from regularly scheduled lease payments and proceeds from the disposal of equipment.\nThe decline in 1993 losses resulted from improvements in the Company's overall collection procedures and improved economic conditions. The decline in 1992 losses resulted from a more seasoned and smaller lease portfolio. The losses incurred in 1991 related primarily to the overall recessionary environment.\nWHOLESALE NOTES. The following table shows wholesale note payments 60 days or more past due in millions of dollars and as a percentage of wholesale notes receivable:\nThe following table shows wholesale note losses in millions of dollars and as a percentage of wholesale note amounts liquidated:\nThe losses in 1993 and 1991 resulted primarily from relatively large losses incurred with two recreational vehicle dealers, one in each of those years.\nCOMPETITION\nThe businesses in which the Company is engaged are highly competitive. The Company competes for customers based upon customer service and finance rates (or time-price differentials) charged. The proportion of John Deere equipment retail sales and leases financed by the Company is influenced by conditions prevailing in the agricultural equipment, industrial equipment and lawn and grounds care equipment industries, in the financial markets, and in business generally. A significant portion of such retail sales during 1993 were financed by the Company. A substantial part of the retail sales and leases eligible for financing by the Company is financed by others, including banks and other finance and leasing companies.\nThe Company attempts to emphasize convenient service to retail customers and to offer terms desired in its specialized markets such as seasonal installment schedules of repayment and rental. The Company's sales and loan finance rates, time-price differentials and lease rental rates are believed to be in the range of those of sales finance and leasing companies generally, although not as low as those of some banks and other lenders and lessors.\nREGULATION\nIn a number of states, the maximum finance rate or time-price differential on retail notes is limited by state law. The present state limitations have not, thus far, significantly limited the Company's variable-rate finance charges, which are determined in relation to a base rate quoted by a bank, nor the fixed-rate finance charges established by the Company. However, if interest rate levels should increase, maximum state rates or time-price differentials could affect the Company by preventing the variable rates on outstanding variable-rate retail notes from increasing above the maximum state rate or time-price differential, and/or by limiting the fixed rates or time-price differentials on new notes. In some states, the Company may be able to qualify new retail notes for a higher maximum limit by using retail installment sales contracts (rather than loan contracts) or by using fixed-rate rather than variable-rate contracts.\nIn addition to rate regulation, various state and federal laws and regulations apply to some Receivables and Leases, principally retail notes for goods sold for personal, family or household use and to Farm Plan and John Deere revolving charge accounts receivable for such goods. To date, such laws and regulations have not had a significant, adverse effect on the Company.\nITEM 2.\n\n\nITEM 2. PROPERTIES.\nThe Company's properties principally consist of office equipment and leased office space in Reno, Nevada; West Des Moines, Iowa; Moline, Illinois; Madison, Wisconsin; and Ft. Lauderdale, Florida.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS.\nThe Company is subject to various unresolved legal actions which arise in the normal course of its business. The most prevalent of such actions relates to state and federal regulations concerning retail credit. There are various claims and pending actions against the Company with respect to commercial and consumer financing matters. These matters include lawsuits pending in federal and state courts in Texas alleging that certain of the Company's retail finance contracts for recreational vehicles and boats violate certain technical provisions of Texas consumer credit statutes dealing with maximum rates, licensing and disclosures. The plaintiffs in Texas claim they are entitled to common law and statutory damages and penalties. On November 6, 1992, the federal District Court certified a federal class action under Rule 23(b)(3) of the Federal Rules of Civil Procedure in an action brought by Russell Durrett, individually and on behalf of others, against John Deere Company (filed in state court on February 19, 1992 and removed on February 26, 1992 to the United States District Court for the Northern District of Texas, Dallas Division). On October 12, 1993, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992, the 281st District Court for Harris County, Texas, certified a class under Rules 42(b)(1)(A), 42(b)(1)(B) and 42(b)(2) of the Texas Rules of Civil Procedure, of all persons who opt out of the federal class action. The Company believes that it has substantial defenses and intends to defend the actions vigorously. Although it is not possible to predict the outcome of these unresolved legal actions, and the amounts of claimed damages and penalties are large, the Company believes that these unresolved legal actions will not have a material adverse effect on its consolidated financial position.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOmitted pursuant to instruction J(2).\nPART II\nITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAll of the Capital Corporation's common stock is owned by John Deere Credit Company, a finance holding company that is wholly-owned by Deere & Company.\nIn 1993, the Capital Corporation paid a cash dividend to John Deere Credit Company of $82 million, which in turn paid an $82 million cash dividend to Deere & Company. Similarly during 1992, the Capital Corporation paid a $70 million dividend. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA.\nOmitted pursuant to instruction J(2).\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1993 COMPARED WITH 1992\nTotal acquisitions of Receivables and Leases by the Company increased five percent during 1993 compared with acquisitions in 1992. The higher acquisitions this year resulted from an increased volume of John Deere leases, revolving charge accounts and wholesale receivables, which more than offset lower acquisitions of retail notes. Receivables and Leases held by the Company at October 31, 1993 totaled $3.437 billion compared with $4.060 billion one year ago. This decrease resulted from sales of retail notes during 1993. Receivables and Leases administered, which include retail notes previously sold but still administered, amounted to $4.873 billion at the end of 1993 compared with $4.796 billion at October 31, 1992.\nDuring 1993, net retail notes (face value less unearned finance income) acquired by the Company decreased three percent compared with 1992. Net retail note acquisitions totaled $2.136 billion during 1993 compared with 1992 acquisitions of $2.207 billion. Acquisitions of recreational product retail notes accounted for nine percent of total note acquisitions in 1993 and 11 percent in 1992.\nNet retail note acquisitions from John Deere decreased by $22 million in 1993, due primarily to a larger volume of cash purchases by John Deere customers and a more competitive agricultural financing environment. Lower acquisitions of agricultural and lawn and grounds care equipment notes were partially offset by higher acquisitions of industrial equipment notes. Note acquisitions in 1993 from John Deere continued to represent a significant proportion of the total United States retail sales of John Deere equipment.\nNet acquisitions of recreational product retail notes, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of several unrelated manufacturers, were $202 million in 1993 compared with $251 million in 1992. This decline was due mainly to a more competitive market for recreational product financing and more selective acquisition criteria.\nAt October 31, 1993, the net amount of retail notes held by the Company was $2.792 billion compared to $3.509 billion last year. Included in these amounts were recreational product notes of $804 million in 1993 and $870 million in 1992. The net balance of John Deere retail notes decreased from $2.639 billion at October 31, 1992 to $1.988 billion at the end of 1993, even though net retail\nnotes acquired exceeded collections. This decrease resulted primarily from the sale of retail notes during 1993. The Company periodically sells retail notes as one of several funding techniques. In 1993 and in 1992, the Company received net proceeds of $1.143 billion and $455 million, respectively, from the sale of retail notes to limited-purpose business trusts which utilized the notes as collateral for the issuance of asset backed securities to the public. During 1992, the Company also sold retail notes to other financial institutions receiving proceeds of $228 million. The net balance of retail notes administered by the Company, which include retail notes previously sold, amounted to $4.185 billion at 31 October 1993, compared with $4.197 billion at 31 October 1992. The net balance of retail notes previously sold was $1.394 billion at October 31, 1993 compared with $688 million at October 31, 1992. Additional sales of retail notes are expected to be made in the future. On October 31, 1993, the Company was contingently liable for recourse in the maximum amount of $108 million on retail notes sold.\nRetail notes bearing variable finance rates totaled 57 percent of the total retail note portfolio at October 31, 1993 compared with 54 percent one year earlier. The Company actively manages the increased interest rate risk posed by fixed-rate retail notes through the issuance of fixed-rate borrowings and the use of financial instruments such as interest rate swaps and interest rate caps. See \"Capital Resources and Liquidity\" on pages 22 through 24.\nAt the end of fiscal 1993, revolving charge accounts receivable totaled $331 million, an increase of 24 percent compared with $268 million at October 31, 1992. The balance at October 31, 1993 included $147 million of John Deere Credit Revolving Plan receivables (including a small balance of marine finance receivables) and $184 million of Farm Plan receivables compared with $114 million and $154 million, respectively, at October 31, 1992. The John Deere Credit Revolving Plan, which was introduced in 1993, contains terms that increase the maximum amount financed, offer more attractive financing conditions and provide more flexible payment terms. Revolving charge account acquisitions increased 23 percent in 1993 compared with last year.\nThe portfolio of net financing leases totaled $85 million at both October 31, 1993 and October 31, 1992. The net investment in operating leases was $119 million and $85 million at the end of 1993 and 1992, respectively. Overall, lease acquisitions increased 84 percent in 1993 primarily due to a new lease program applicable to some models of John Deere tractors. In addition, $19 million of municipal leases were sold to Deere & Company during 1993 compared with $21 million sold last year. At October 31, 1993, the net unpaid balance of leases sold to John Deere was $43 million compared with $48 million at October 31, 1992.\nWholesale notes on recreational vehicle and John Deere engine inventories totaled $110 million at October 31, 1993 compared with $112 million at October 31, 1992.\nTotal Receivable and Lease amounts 60 days or more past due were $12.7 million at October 31, 1993 compared with $14.6 million at October 31, 1992.\nThese past-due amounts represented .30 percent of the face value of Receivables and Leases held at October 31, 1993 and .29 percent at October 31, 1992. The total face amount of retail notes held with any installment 60 days or more past due was $42.3 million at October 31, 1993 compared with $55.6 million one year earlier. The amount of retail note installments 60 days or more past due was $7.0 million at both October 31, 1993 and October 31, 1992. These past-due installments represented .19 percent of the unpaid face value of retail notes at October 31, 1993 and .15 percent at October 31, 1992.\nThe total balance of revolving charge accounts receivable 60 days or more past due was $5.3 million at October 31, 1993 compared with $6.4 million at October 31, 1992. These past due amounts represented 1.6 and 2.4 percent of the revolving charge accounts receivable held at each of those respective dates. The total balance of financing and operating lease payments 60 days or more past due was $0.5 million at October 31, 1993 compared with $1.2 million at October 31, 1992. These past-due installments represented .3 percent of the total lease payments receivable at October 31, 1993 and .8 percent at October 31, 1992.\nAt October 31, 1993, the Company's allowance for credit losses, totaled $77 million and represented 2.3 percent of the total net Receivables and Leases financed compared with $83 million and 2.0 percent, respectively, one year earlier. Deposits withheld from dealers and merchants, which are available for potential credit losses, totaled $105 million at October 31, 1993 compared with $101 million one year earlier.\nThe Capital Corporation's consolidated income for the fiscal year ended October 31, 1993, before the cumulative effect of adopting new accounting standards related to postretirement and postemployment benefits, was $111.0 million compared with 1992 net income of $95.0 million. The ratio of earnings before fixed charges to fixed charges was 1.99 to 1 (excluding the effects of accounting changes) for 1993 compared with 1.74 to 1 last year. The improvement in net income resulted primarily from higher securitization and servicing fee income from retail notes previously sold, lower credit losses, higher financing margins, and increased gains from the sale of retail notes, which more than offset the effects of a lower balance of Receivables and Leases financed. Net income totaled $107.2 million in 1993, including the cumulative effect of adopting FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and FASB Statement No. 112, Employers' Accounting for Postemployment Benefits.\nTotal revenues decreased one percent during 1993 to $466 million compared with $471 million in 1992. The average balance of total net Receivables and Leases financed was seven percent lower in 1993 compared with last year due primarily to the sale of receivables during 1993. Revenues were also affected by the lower level of interest rates and the corresponding lower finance charges earned in 1993 compared with last year. These decreases in revenues were partially offset by higher securitization and servicing fee income from retail notes previously sold. However, borrowing rates were also lower this year resulting in the slightly improved financing margins. The lower borrowing rates and decrease\nin average borrowings this year resulted in an 11 percent decrease in interest expense, which totalled $168 million in 1993 compared with $189 million last year. Average borrowings were $3.127 billion in 1993, a seven percent decline from last year's average borrowings of $3.379 billion. The weighted average annual interest rate incurred on all interest-bearing borrowings this year declined to 5.1 percent from 5.4 percent in 1992.\nFinance income earned on retail notes was $314 million this year compared with $356 million in 1992, a decrease of 12 percent. The average balance of the net retail note portfolio financed during 1993 was 10 percent lower than during 1992.\nRevenues earned on revolving charge accounts amounted to $54 million in 1993, a 14 percent increase over revenues of $47 million earned during 1992. This increase was primarily due to a 20 percent increase in the average balance of Farm Plan receivables financed and a 15 percent increase in the average balance of John Deere Credit Revolving Plan receivables financed in 1993 compared with 1992.\nThe average net investment in financing and operating leases decreased by two percent in 1993 compared with 1992. However, total lease revenues increased eight percent to $39.6 million in 1993 compared with $36.8 million in 1992. Lease revenues were favorably affected in 1993 by a significant increase in rentals earned on operating leases.\nThe net gain on retail notes sold totaled $15.6 million during 1993 compared with $8.5 million for 1992. The Company received proceeds from the sale of retail notes in the amount of $1.143 billion during 1993 and $683 million in 1992. Securitization and servicing fee income totaled $22.3 million in 1993 compared with $1.1 million during 1992. Securitization and servicing fee income relates to retail notes sold to limited-purpose business trusts and includes the amortization of present value receivable amounts from the trusts established at the time of sale and reimbursed administrative expenses received from the trusts. The amount of securitization and servicing fee income was small in 1992 because the first retail note sale to a trust occurred near the end of that year.\nAdministrative and operating expenses increased 18 percent to $75 million in 1993 compared with $63 million in 1992. These expenses increased primarily due to higher employment costs and legal expenses. The Company incurred additional costs associated with efforts relating to future growth and improving the quality of the portfolio.\nThe provision for credit losses declined to $28 million in 1993 from $48 million last year mainly as a result of improved credit experience resulting in lower Receivable and Lease write-offs. The decline in write-offs related particularly to recreational product retail notes and John Deere industrial equipment retail notes.\nACCOUNTING CHANGES\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Prior quarters of 1993 were restated as required by this Statement. This Statement generally requires the accrual of retiree health care and other postretirement benefits during employees' years of active service. The Company elected to recognize the pretax transition obligation of $5.4 million ($3.6 million net of deferred income taxes) as a one-time charge to earnings in the current year. This obligation represents the portion of future retiree benefit costs related to service already rendered by both active and retired employees up to November 1, 1992. The 1993 postretirement benefits expense and related disclosures have been determined according to the provisions of FASB Statement No. 106. For years prior to 1993, postretirement benefits were generally included in costs as covered expenses were actually incurred. The adoption of FASB Statement No. 106 resulted in an incremental pretax expense of $.2 million compared with the expense determined under the previous accounting principle. This increase in the current year expense is in addition to the previously mentioned one-time charge relating to the transition obligation.\nIn the fourth quarter of 1993, the Company also adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. This Statement requires the accrual of certain benefits provided to former or inactive employees after employment but before retirement during employees' years of active service. The Company previously accrued certain disability related benefits when the disability occurred. Results for the first quarter of 1993 were restated for the cumulative pretax charge resulting from this change in accounting as of November 1, 1992 which totaled $.3 million ($.2 million net of deferred income taxes). The adoption of FASB Statement No. 112 had an immaterial effect on 1993 expenses.\n1992 COMPARED WITH 1991\nTotal acquisitions of Receivables and Leases by the Company decreased three percent during 1992 compared with acquisitions in 1991. Receivables and Leases held by the Company at October 31, 1992 totaled $4.060 billion compared with $4.398 billion one year ago. This decrease resulted from sales of retail notes during 1992. Receivables and Leases administered, which include retail notes previously sold but still administered, amounted to $4.796 billion at the end of 1992 compared with $4.693 billion at October 31, 1991.\nDuring 1992, the volume of net retail notes acquired by the Company decreased eight percent compared with 1991. Net retail note acquisitions totaled $2.207 billion during 1992 compared with 1991 acquisitions of $2.400 billion. Acquisitions of recreational product retail notes accounted for 11 percent of total note acquisitions in 1992 and 13 percent in 1991.\nNet retail note acquisitions from John Deere decreased by $142 million in 1992, due primarily to a decrease in retail sales of John Deere agricultural equipment. Acquisitions of industrial equipment retail notes also were lower in 1992 while lawn and grounds care equipment note acquisitions were significantly higher due mainly to finance waiver programs on lawn and garden tractors. Note acquisitions in 1992 from John Deere continued to represent a significant proportion of the total United States retail sales of John Deere equipment.\nNet acquisitions of recreational product retail notes were $251 million in 1992 compared with $301 million in 1991. This decline was due mainly to a more competitive financing environment and the development of more selective retail note acquisition criteria by the Company over the past few years.\nAt October 31, 1992, 1991 and 1990, the net amount of retail notes held by the Company was $3.509 billion, $3.854 billion and $3.074 billion, respectively. Included in these amounts were non-Deere notes of $870 million, $888 million and $773 million at those respective dates. The net balance of John Deere retail notes decreased from $2.966 billion at October 31, 1991 to $2.639 billion at the end of 1992. John Deere retail notes totaled $2.301 billion at the end of 1990. The decrease in 1992 resulted primarily from the sale of retail notes. During 1992, the Company sold retail notes to other financial institutions and the public, receiving net proceeds of $683 million. Notes were not sold in 1991. At October 31, 1992, 1991 and 1990, the net unpaid balance of retail notes sold was $688 million, $242 million and $521 million, respectively. Additional sales of retail notes are expected to be made in the future.\nRetail notes bearing variable finance rates totaled 54 percent of the total retail note portfolio at October 31, 1992 compared with 56 percent one year earlier.\nRevolving charge accounts receivable totaled $268 million at October 31, 1992 compared with $240 million one year earlier. The increase in the outstanding balance at October 31, 1992 was due mainly to an increase in Farm Plan volume. The October 31, 1992 balance of revolving charge accounts receivable includes $114 million of credit card receivables and $154 million of Farm Plan receivables, compared with $112 million and $128 million, respectively, at October 31, 1991.\nAt October 31, 1992, the net investment in financing and operating leases on John Deere equipment was $170 million compared with $213 million at October 31, 1991. Lease acquisitions declined 27 percent in 1992 compared with 1991 due to a decrease in agricultural lease activity and competitive pressures. Lease liquidations during 1992 exceeded acquisitions, as the high lease acceptances of several years ago continued to mature. Also, $21 million net value of municipal leases were sold to John Deere during 1992 compared with $27 million sold in 1991. At October 31, 1992, the net unpaid balance of leases sold to John Deere was $48 million compared with $53 million at October 31, 1991.\nWholesale notes receivable totaled $112 million at October 31, 1992 compared with $91 million at October 31, 1991, as wholesale note acquisitions increased 37 percent in 1992.\nTotal Receivable and Lease amounts 60 days or more past due were $14.6 million at October 31, 1992 compared with $27.1 million at October 31, 1991. These past due amounts represented .29 percent of the face value of Receivables and Leases held at October 31, 1992 and .49 percent at October 31, 1991. The total face amount of retail notes held with any installment 60 days or more past due was $55.6 million at October 31, 1992 compared with $108.0 million one year earlier. The amount of retail note installments 60 days or more past due was $7.0 million at October 31, 1992, a decrease of 60 percent compared with $17.5 million at October 31, 1991. These past-due installments represented .15 percent of the unpaid face value of retail notes held at October 31, 1992 and .35 percent at October 31, 1991.\nThe total balance of revolving charge accounts receivable 60 days or more past due was $6.4 million at October 31, 1992 compared with $8.5 million at October 31, 1991. These past due amounts represented 2.4 and 3.5 percent of the revolving charge accounts receivable held at each of those respective dates. The total balance of financing and operating lease payments 60 days or more past due was $1.2 million at October 31, 1992 compared with $1.0 million at October 31, 1991. These past-due installments represented .8 percent of the total lease payments receivable at October 31, 1992 and .5 percent at October 31, 1991.\nAt October 31, 1992, the Company's allowance for credit losses totaled $83 million and represented 2.0 percent of the total net Receivables and Leases financed compared with $78 million and 1.8 percent at October 31, 1991. Deposits withheld from dealers and merchants amounted to $101 million at October 31, 1992 compared with $99 million one year earlier.\nNet income in 1992 totaled $95.0 million, an increase of 30 percent compared with 1991 income of $73.0 million. The ratio of earnings before fixed charges to fixed charges was 1.74 to 1 for 1992 compared with 1.48 to 1 in 1991. The improvement in net income in 1992 resulted primarily from a higher average volume of Receivables and Leases financed and improved credit loss experience. Results in 1992 also benefited from after-tax income of $5.6 million from sales of retail notes.\nThe average balance of total net Receivables and Leases financed was seven percent higher in 1992 compared with 1991, although the year-end balance was lower due to the sale of a substantial amount of retail notes in October 1992. However, total revenues decreased three percent to $471 million in 1992 compared with $487 million in 1991, as the average yield earned on the portfolio was lower this year. While revenues were affected by the lower level of interest rates and correspondingly lower finance charges earned in 1992 compared with last year, borrowing costs were also lower this year. Interest expense totaled $189 million in 1992, a decrease of 17 percent compared with $228 million in 1991. Total\naverage borrowings were $3.379 billion in 1992, an 11 percent increase over fiscal year 1991 average borrowings of $3.053 billion. The weighted average interest rate incurred on all interest-bearing borrowings during 1992 declined to 5.4 percent from 7.2 percent in 1991.\nFinance income earned on retail notes was $356 million this year compared with $383 million in 1991, a decrease of seven percent. The average balance of the net retail note portfolio financed during 1992 was seven percent higher than during 1991.\nRevenues earned on revolving charge accounts amounted to $47 million in 1992, an 11 percent increase over revenues of $43 million earned during 1991. This increase was primarily due to a 17 percent increase in the average balance of Farm Plan receivables financed and a 10 percent increase in the average balance of credit card receivables financed in 1992 compared with 1991.\nThe average net investment in financing and operating leases decreased by 13 percent in 1992 compared with 1991. In addition, total lease revenues decreased slightly to $36.8 million in 1992 compared with $36.9 million in 1991. Lease revenues were favorably affected in 1992 by a significant increase in rentals earned on operating leases.\nAdministrative and operating expenses for 1992 were $63 million, an increase of eight percent compared with $59 million for 1991. These expenses increased primarily due to the costs associated with the larger average portfolio financed.\nThe provision for credit losses decreased to $48 million in 1992 from $66 million in 1991 mainly as a result of improved credit experience resulting in lower Receivable and Lease write-offs. The most significant decline in write-offs related to recreational product notes, resulting primarily from more selective note acquisition criteria used by the Company. Write-offs of recreational product notes totaled $24.2 million in 1992 compared with $33.3 million in 1991.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Company relies on its ability to raise substantial amounts of funds to finance its Receivable and Lease portfolios. The Company's primary sources of funds for this purpose are a combination of borrowings and equity capital. Additionally, the Company periodically sells substantial amounts of retail notes in the public market. The Company's ability to obtain funds is affected by its debt ratings, which are closely related to the outlook for and the financial condition of Deere & Company, and the nature and availability of support facilities, such as its lines of credit. For information regarding Deere & Company and its business, see Exhibit 99.1.\nThe Company's ability to meet its debt obligations is supported in a number of ways as described below. All commercial paper issued is backed by bank credit lines. The assets of the Company are self-liquidating in nature. A strong\nequity position is available to absorb unusual losses on these assets. Liquidity is also provided by the Company's ability to sell or \"securitize\" these assets. Asset-liability risk is also actively managed to minimize exposure to interest rate fluctuations.\nThe Company's business is somewhat seasonal, with overall acquisitions of Receivables and Leases traditionally higher in the second half of the fiscal year than in the first half, and overall collections of Receivables and Leases traditionally somewhat higher in the first six months than in the last half of the fiscal year.\nThe Company's cash flows from operating activities were $157 million in 1993. See \"Statement of Consolidated Cash Flows\" on page 34. Net cash provided by investing activities totaled $477 million in 1993, primarily due to net proceeds of $1.143 billion received from the securitization and sale of receivables in the public market, which was partially offset by funds used for Receivable and Lease acquisitions which exceeded collections by $698 million in 1993. Collections of receivables in 1993 were slightly lower than last year, due primarily to the lower retail note portfolio financed in 1993. The aggregate cash provided by operating and investing activities was used for financing activities and a $74 million increase in cash and cash equivalents. Cash used for financing activities totaled $561 million in 1993, representing a net decrease in outside borrowings of $853 million and the payment of an $82 million dividend to Deere & Company which were partially offset by a $374 million increase in payables to Deere & Company.\nOver the past three years, operating activities have provided $453 million in cash. Proceeds from the sale of receivables and an increase in payables to Deere & Company provided $1.893 and $423 million, respectively, during the same period. These amounts were used mainly to fund Receivable and Lease acquisitions which exceeded collections by $2.101 billion, a decrease of $438 million in net outside borrowings, $202 million in dividends and an increase in cash and cash equivalents of $67 million.\nIn common with other large finance and credit companies, the Company actively manages the relationship of the types and amounts of its funding sources to its Receivable and Lease portfolios in an effort to diminish risk due to interest rate and currency fluctuations, while responding to favorable competitive and financing opportunities. Accordingly, from time to time, the Company enters into interest rate swap and interest rate cap agreements to hedge its interest rate exposure in amounts corresponding to a portion of its borrowings. See notes 4 and 5 to the consolidated financial statements for further details. The credit and market risks under these agreements are not considered to be significant.\nTotal indebtedness amounted to $2.777 billion at October 31, 1993 compared with $3.256 billion at October 31, 1992. Total short-term indebtedness amounted to $1.299 billion at October 31, 1993 compared with $2.017 billion at October 31, 1992. See note 4 to the consolidated financial statements. Total long-term indebtedness amounted to $1.478 billion at October 31, 1993 and $1.239 billion at October 31, 1992. See note 5 to the consolidated financial statements. The\ndecrease in total indebtedness at October 31, 1993 compared with October 31, 1992 was due primarily to the decline in Receivables and Leases financed. The ratio of total interest-bearing debt to stockholder's equity was 3.8 to 1 and 4.6 to 1 at October 31, 1993 and October 31, 1992, respectively.\nIn 1993, the Company issued $150 million of 5% notes due in 1995 and $200 million of 4-5/8% notes due in 1996. The Company also retired $150 million of 7.40% notes due in 1993, $125 million of 9.0% debentures due in 1993 and $47 million of 7-1/2% debentures due in 1998. In November 1993, the Capital Corporation announced that on January 4, 1994 it will redeem the $40 million balance of outstanding 9.35% subordinated debentures due 2003. Additional information on these borrowings is included in the discussion of \"Long-Term Borrowings\" on page 41.\nDuring 1993, the Capital Corporation issued $337 million and retired $176 million of medium-term notes. At October 31, 1993, $737 million of medium-term notes were outstanding having original maturity dates of between one and seven years and interest rates that ranged from 3.4 percent to 9.5 percent.\nAt October 31, 1993, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $3.025 billion. Included in the total credit lines were three long-term credit agreement commitments totaling $3.016 billion. At October 31, 1993, $2.265 billion of the lines of credit were unused. For the purpose of computing unused credit lines, the aggregate of total short-term borrowings, excluding the current portion of long-term borrowings, of the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada) were considered to constitute utilization. Annual facility fees on the credit agreements are paid by Deere & Company and a portion is charged to the Capital Corporation based on utilization.\nIn 1993, the Capital Corporation paid a dividend of $82 million to John Deere Credit Company, which, in turn, paid an $82 million dividend to Deere & Company. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee accompanying table of contents of financial statements.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nOmitted pursuant to instruction J(2).\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION.\nOmitted pursuant to instruction J(2).\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nOmitted pursuant to instruction J(2).\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nOmitted pursuant to instruction J(2).\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) Financial Statements\n(2) Financial Statement Schedules\nSee the table of contents to financial statements and schedules immediately preceding the financial statements and schedules to consolidated financial statements.\n(3) Exhibits\nSee the index to exhibits immediately preceding the exhibits filed with this report.\n(b) Reports on Form 8-K\nCurrent Report on Form 8-K dated August 24, 1993 (Items 5 and 7).\nCurrent Report on Form 8-K dated August 4, 1993 (Items 5 and 7).\n(THIS PAGE INTENTIONALLY LEFT BLANK)\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nJOHN DEERE CAPITAL CORPORATION\nBy: /s/ Hans W. Becherer ---------------------- Hans W. Becherer, Chairman Date: 24 January 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nSignature Title Date ----------- ----- ----\n/s/ Hans W. Becherer Director, Chairman and Principal ) -------------------- Executive Officer ) Hans W. Becherer ) ) /s/ J. Michael Dunn Director ) -------------------- ) J. Michael Dunn ) ) /s/ J. W. England Director, Vice President and ) ------------------- Principal Accounting Officer ) J. W. England ) ) /s/ B. L. Hardiek Director ) ------------------- ) B. L. Hardiek ) ) /s/ B. C. Harpole Director ) ------------------- ) B. C. Harpole ) ) /s/ D. E. Hoffmann Director ) ------------------- ) D. E. Hoffmann ) ) /s/ J. K. Lawson Director ) 24 January 1994 ------------------- J. K. Lawson\n/s/ Pierre E. Leroy Director ) - -------------------- ) Pierre E. Leroy ) ) /s/ M. P. Orr Director and President ) - -------------------- ) M. P. Orr ) ) /s/ E. L. Schotanus Director, Vice President and ) 24 January 1994 - -------------------- Principal Financial Officer ) E. L. Schotanus ) ) /s/ D. H. Stowe, Jr. Director ) - -------------------- ) D. H. Stowe, Jr. ) ) /s/ S. E. Warren Director ) - -------------------- ) S. E. Warren )\n[LOGO]\nINDEPENDENT AUDITORS' REPORT\nJohn Deere Capital Corporation:\nWe have audited the accompanying consolidated balance sheets of John Deere Capital Corporation and subsidiaries as of October 31, 1993 and 1992 and the related statements of consolidated income and retained earnings and of consolidated cash flows for each of the three years in the period ended October 31, 1993. Our audits also included the financial statement schedules listed in the Table of Contents on page 31. These financial statements and financial statement schedules are the responsibility of the company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of John Deere Capital Corporation and subsidiaries at October 31, 1993 and 1992 and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, effective November 1, 1992 the company changed its method of accounting for postretirement benefits other than pensions.\nDELOITTE & TOUCHE\nDecember 10, 1993\n[LOGO]\nFINANCIAL STATEMENTS: Page ----\nJohn Deere Capital Corporation and Subsidiaries (consolidated):\nStatement of Consolidated Income and Retained Earnings for the Years Ended October 31, 1993, 1992 and 1991...............32\nConsolidated Balance Sheet, October 31, 1993 and 1992...........33\nStatement of Consolidated Cash Flows for the Years Ended October 31, 1993, 1992 and 1991...............................34\nNotes to Consolidated Financial Statements......................35\nFINANCIAL STATEMENT SCHEDULES:\nSchedule VIII - Valuation and Qualifying Accounts for the Years Ended October 31, 1993, 1992 and 1991...................46\nSchedule IX - Short-term Borrowings for the Years Ended October 31, 1993, 1992 and 1991...............................47\nSCHEDULES OMITTED\nThe following schedules are omitted because of the absence of the conditions under which they are required:\nI, II, III, IV, V, VI, VII, X, XI, XII, XIII and XIV.\nSTATEMENT OF CONSOLIDATED INCOME AND RETAINED EARNINGS\nCONSOLIDATED BALANCE SHEET\nSTATEMENT OF CONSOLIDATED CASH FLOWS\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCORPORATE ORGANIZATION\nJohn Deere Capital Corporation (Capital Corporation) is a wholly-owned subsidiary of John Deere Credit Company, a finance holding company which is wholly-owned by Deere & Company. The Capital Corporation and its subsidiaries, Deere Credit Services, Inc. (DCS), Farm Plan Corporation (FPC), Deere Credit, Inc. (DCI), and John Deere Receivables, Inc. (JDRI), are collectively called the Company. Deere & Company with its other wholly-owned subsidiaries are collectively called John Deere.\nRetail notes, revolving charge accounts, financing leases and wholesale notes receivable are collectively called \"receivables.\" Receivables and operating leases are collectively called \"receivables and leases.\"\nThe risk of credit losses applicable to John Deere retail notes and leases, net of recovery from withholdings from John Deere dealers, is borne by the Company. John Deere is compensated by the Company at a rate of 2.9 percent or less of the finance income earned, depending on prevailing bank interest rate levels, for originating retail notes on John Deere products. John Deere is reimbursed by the Company for staff support and other administrative services at estimated cost, and for credit lines provided by Deere & Company based on utilization of the lines. John Deere is compensated for originating leases on John Deere products and is reimbursed for staff support in a manner similar to the procedures for retail notes.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the financial statements of the Capital Corporation and its subsidiaries, all of which are wholly-owned.\nACCOUNTING CHANGES\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Prior quarters of 1993 were restated as required by this Statement. This Statement generally requires the accrual of retiree health care and other postretirement benefits during employees' years of active service. The Company elected to recognize the pretax transition obligation of $5.4 million ($3.6 million net of deferred income taxes) as a one-time charge to earnings in the current year. This obligation represents the portion of future retiree benefit costs related to service already rendered by both active and retired employees up to November 1, 1992. The 1993 postretirement benefits expense and related disclosures have been determined according to the provisions of FASB Statement No. 106. For years prior to 1993, postretirement benefits were generally included in costs as covered expenses were actually incurred. The adoption of FASB Statement No. 106 resulted in an incremental pretax expense of $.2 million compared with the expense determined under the previous accounting principle. This increase in the current year expense is in addition to the previously mentioned one-time charge relating to the transition obligation.\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. This Statement requires the accrual of certain benefits provided to former or inactive employees after employment but before retirement during employees' years of active service. The Company previously accrued certain disability related benefits when the disability occurred. Results for the first quarter of 1993 were restated for the cumulative pretax charge resulting from this change in accounting as of November 1, 1992 which totaled $.3 million ($.2 million net of deferred income taxes). The adoption of FASB Statement No. 112 had an immaterial effect on 1993 expenses.\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 107, Disclosures about Fair Values of Financial Instruments. Disclosures of the fair values of financial instruments which do not approximate the carrying values in the financial statements are included in the appropriate financial statement notes. Fair values of other financial instruments approximate the carrying amounts because of the short maturities or current market interest rates of those instruments.\nIn the second quarter of 1992, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. See note 10 for further information.\nRETAIL NOTES RECEIVABLE\nThe Company purchases and finances retail notes from John Deere's agricultural equipment, industrial equipment and lawn and grounds care equipment sales branches in the United States. The notes are acquired by the sales branches through John Deere retail dealers and principally originate in connection with retail sales by dealers of new John Deere equipment and used equipment. The Company also purchases and finances retail\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nnotes unrelated to John Deere equipment, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine mortgage service companies (recreational product retail notes).\nFinance income included in the face amount of retail notes is amortized into income over the lives of the notes on the effective-yield basis. Unearned finance income on variable-rate notes is adjusted monthly based on fluctuations in the base rate of a specified bank.\nCosts incurred in the acquisition of retail notes are deferred and amortized into income over the expected lives of the notes on the effective-yield basis.\nA portion of the finance income earned by the Company arises from retail sales of John Deere equipment sold in advance of the season of use or in other sales promotions by John Deere on which finance charges are waived by John Deere for a period from the date of sale to a specified subsequent date. Some low-rate financing programs are also offered by John Deere. The Company receives compensation from John Deere approximately equal to the normal net finance charge on retail notes for periods during which finance charges have been waived or reduced. The portions of the Company's finance income earned that were received from John Deere on retail notes containing waiver of finance charges or reduced rates were 19 percent in 1993, 17 percent in 1992 and 20 percent in 1991.\nA deposit equal to one percent of the face amount of John Deere agricultural and lawn and grounds care equipment retail notes originating from each dealer is withheld from that dealer and recorded by the Company. Any subsequent retail note losses are charged against the withheld deposits. To the extent that a loss on a retail note cannot be absorbed by deposits withheld from the dealer from which the retail note was acquired, it is charged against the Company's allowance for credit losses. At the end of each calendar year, the balance of each dealer's withholding account in excess of a specified percent (currently 3 percent) of the total balance outstanding on retail notes originating with that dealer is remitted to the dealer, and any negative balance in the dealer withholding account is written off and absorbed by the Company's allowance for credit losses.\nAll John Deere industrial equipment retail notes are currently acquired on a non-recourse basis and there is no withholding of dealer deposits on those notes. This procedure originated in January 1992. Industrial notes acquired prior to January 1992 remain subject to the agricultural and lawn and grounds care equipment procedures, noted in the above paragraph, until the notes are paid in full, or the withholding accounts are depleted. Because of this change, the allowance for credit losses was increased to compensate for the additional credit risk. The Company does not withhold deposits on recreational product retail notes.\nThe Company requires that theft and physical damage insurance be carried on all equipment leased or securing retail notes. The customer may, at his own expense, have the Company purchase this insurance or obtain it from other sources. Theft and physical damage insurance is also required on wholesale notes and can be purchased through the Company or from other sources. Insurance is not required on revolving charge accounts.\nGenerally, when an account becomes 120 days delinquent, accrual of finance income is suspended, the collateral is repossessed or the account is designated for litigation, and the estimated uncollectible amount, after charging the dealer's withholding account, if any, is written off to the allowance for credit losses.\nREVOLVING CHARGE ACCOUNTS RECEIVABLE\nRevolving charge account income is generated primarily by two revolving credit products: Farm Plan and the John Deere Credit Revolving Plan.\nFarm Plan is primarily used by agri-businesses to finance customer purchases, such as parts and service labor, which would otherwise be carried by the merchants as accounts receivable. Farm Plan income includes a discount paid by merchants for the purchase of customer accounts and finance charges paid by customers on their outstanding revolving charge account balances. Merchant recourse and a merchant reserve are established on some receivables purchased.\nThe John Deere Credit Revolving Plan is used primarily by retail customers of John Deere dealers to finance lawn and grounds care equipment. Income includes a discount paid by dealers on most transactions and finance charges paid by customers on their outstanding account balances.\nAccrual of revolving charge account income is suspended generally when an account becomes 120 days delinquent. Accounts are deemed to be uncollectible and written off to the allowance for credit losses when delinquency reaches 180 days for a Farm Plan account and 150 days for John Deere Credit Revolving Plan accounts.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDIRECT FINANCING LEASES AND EQUIPMENT ON OPERATING LEASES\nThe Company leases John Deere agricultural equipment, industrial equipment and lawn and grounds care equipment directly to retail customers.\nAt the time of accepting a lease that qualifies as a direct financing lease under FASB Statement No. 13, the Company records the gross amount of lease payments receivable, estimated residual value of the leased equipment for non-purchase option leases and unearned lease income. The unearned lease income is equal to the excess of the gross lease receivable plus the estimated residual value over the cost of the equipment. The unearned lease income is recognized as revenue over the lease term on the effective-yield method.\nLeases that do not meet the criteria for direct financing leases as outlined by FASB Statement No. 13 are accounted for as operating leases. Rental payments applicable to equipment on operating leases are recorded as income on a straight-line method over the lease terms. Operating lease assets are recorded at cost and depreciated on a straight-line method over the terms of the leases.\nLease acquisition costs are accounted for in a manner similar to the procedures for retail notes.\nDeposits withheld from John Deere dealers and related losses on leases are handled in a manner similar to the procedures for retail notes. In addition, a lease payment discount program, allowing reduced payments over the term of the lease, is administered in a manner similar to finance waiver on retail notes.\nEquipment returned to the Company upon termination of leases and held for subsequent sale or lease is recorded at the estimated wholesale market value of the equipment.\nGenerally, when an account becomes 120 days delinquent, accrual of lease revenue is suspended, the equipment is repossessed or the account is designated for litigation and the estimated uncollectible amount, after charging the dealer's withholding account, if any, is written off to the allowance for credit losses.\nWHOLESALE RECEIVABLES\nThe Company finances recreational vehicle inventory and John Deere engines held by dealers of those products. Wholesale finance income is recognized monthly based on the daily balance of wholesale receivables outstanding and the applicable effective interest rate. Interest rates vary with a prevailing bank base rate, the type of equipment financed and the balance outstanding. Wholesale receivables are secured by the recreational vehicle and engine inventories financed. Although amounts are not withheld from dealers to cover uncollectible receivables, there are repurchase agreements with manufacturers for new inventories held by dealers. Generally, when an account becomes 60 days delinquent, accrual of finance income is suspended, the collateral is repossessed and the estimated uncollectible amount is written off to the allowance for credit losses.\nOTHER RECEIVABLES\nDuring 1993 and 1992, the Company sold retail notes to limited-purpose business trusts, which utilized the notes as collateral for the issuance of asset backed securities to the public. At the time of the sales, \"other receivables\" from the trusts were recorded at net present value. The receivables relate to deposits made pursuant to recourse provisions and other payments to be received under the sales agreements. The receivables will be amortized to their value at maturity using the interest method. The Company is also compensated by the trusts for certain expenses incurred in the administration of these receivables. Securitization and servicing fee income includes both the amortization of the above receivables and reimbursed administrative expenses.\nCONCENTRATION OF CREDIT RISK\nReceivables and leases have significant concentrations of credit risk in the agricultural, industrial, lawn and grounds care, and recreational product business sectors as shown in note 2, \"Receivables and Leases.\" On a geographic basis, there is not a disproportionate concentration of credit risk in any area of the United States. The Company retains as collateral a security interest in the equipment associated with receivables and leases other than revolving charge accounts.\nRECLASSIFICATIONS\nCertain amounts for 1991 and 1992 have been reclassified to conform with 1993 financial statement presentations.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 2 RECEIVABLES AND LEASES\nRETAIL NOTES RECEIVABLE\nRetail notes receivable by product category at October 31 in millions of dollars follow:\nDuring 1993, the average effective yield on retail notes held by the Company was approximately 9.8 percent compared with 10.1 percent in 1992. Retail notes acquired by the Company during the year ended October 31, 1993 had an estimated average original term (based on dollar amounts) of 67 months. During 1992 and 1991, the estimated average original term was 68 and 66 months, respectively. Historically, because of prepayments, the average actual life of retail notes has been considerably shorter than the average original term. During 1993, the Company received net proceeds of $1.143 billion from the sale of retail notes to limited-purpose business trusts, which utilized the notes as collateral for the issuance of asset backed securities to the public. During 1992, the Company received net proceeds of $683 million from the sale of retail notes. At October 31, 1993 and 1992, the net balance of all retail notes previously sold by the Company was $1.394 billion and $688 million, respectively. Additional sales of retail notes are expected to be made in the future. The Company recognizes any gain or loss at the time of the sale of retail notes. The sale price of retail notes sold to financial institutions is subject to subsequent monthly adjustments to reflect changes in short-term interest rates and variations in timing between actual and anticipated collections. The Company acts as agent for the buyers in collection and administration of all the notes it has sold and was contingently liable for recourse in the maximum amount of $108 million and $67 million at October 31, 1993 and 1992, respectively. All retail notes sold are collateralized by security agreements on the related machinery sold to the customers. There is a minimal amount of market risk due to monthly adjustments to the sale price of a small portion of the retail notes. There is no anticipated credit risk related to the nonperformance by the counterparties.\nREVOLVING CHARGE ACCOUNTS RECEIVABLE Revolving charge accounts receivable at October 31, 1993 totaled $331 million compared with $268 million at October 31, 1992. Account holders may pay the account balance in full at any time, or make payments over a number of months according to a payment schedule. A minimum amount is due each month from customers selecting the revolving payment option.\nFINANCING LEASES RECEIVABLE Financing leases receivable by product category at October\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n31 are as follows in millions of dollars:\nResidual values represent the amounts estimated to be recoverable at maturity from disposition of the leased equipment under non-purchase option financing leases. Initial lease terms for financing leases range from 12 months to 72 months. Payments on financing leases receivable at October 31 are scheduled as follows in millions of dollars:\nThe Company sold $19 million of municipal leases to Deere & Company in 1993 compared with $21 million in 1992. At October 31, 1993, the net balance of leases sold was $43 million compared with $48 million at October 31, 1992. Additional sales of leases may be made in the future.\nWHOLESALE RECEIVABLES Wholesale receivables at October 31, 1993 totaled $110 million compared with $112 million at October 31, 1992.\nMaturities range from 12 to 24 months, with scheduled principal reductions from invoice date to maturity.\nEQUIPMENT ON OPERATING LEASES The cost of equipment on operating leases by product category at October 31 follows in millions of dollars:\nInitial lease terms for equipment on operating leases range from 12 months to 72 months. Rental payments for equipment on operating leases at October 31 are scheduled as follows in millions of dollars:\nFAIR VALUE At October 31, 1993, the estimated fair value of total net receivables and leases was $3.516 billion compared with the carrying value of $3.436 billion. The fair values of fixed-rate retail notes and financing leases were based on the discounted values of their related cash flows at current market interest rates. The fair values of variable-rate retail notes, revolving charge accounts and wholesale notes approximate the carrying amounts.\nNOTE 3 ALLOWANCE FOR CREDIT LOSSES\nAllowances for credit losses on receivables and leases are maintained in amounts considered to be appropriate in relation to the receivables and leases outstanding based on estimated collectibility and collection experience.\nAn analysis of the allowance for credit losses on total receivables and losses follows in millions of dollars:\nThe allowance for credit losses represented 2.3 percent, 2.0 percent and 1.8 percent of receivables and leases outstanding at October 31, 1993, 1992 and 1991, respectively. In addition, the Company had $105 million, $101 million and $99 million at October 31, 1993, 1992 and 1991, respectively, of deposits withheld from John Deere dealers and Farm Plan merchants available for certain potential credit losses originating from those dealers and merchants. The lower provisions in 1993 and 1992 resulted from a decrease in write-offs of uncollectible receivables and leases, particularly recreational product retail notes. The decrease in write-offs of recreational product notes resulted primarily from the development of more selective recreational product retail note acquisition criteria by the Company over the past few years and improved collection effectiveness.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 4 SHORT-TERM BORROWINGS\nOn October 31, 1993, short-term borrowings were $1.299 billion, $454 million of which was commercial paper. Short-term borrowings were $2.017 billion one year ago, $1.487 billion of which was commercial paper. Original maturities of commercial paper outstanding on October 31, 1993 ranged up to 244 days. The weighted average remaining term of commercial paper outstanding on October 31, 1993 was approximately 71 days. The Capital Corporation's short-term debt also includes amounts borrowed from Deere & Company, which totaled $439.5 million at October 31, 1993. The Capital Corporation pays a market rate of interest to Deere & Company based on the average outstanding borrowings each month. The weighted average interest rates on all short-term borrowings, excluding current maturities of long-term borrowings, for 1993, 1992 and 1991 were 4.0 percent, 5.0 percent and 6.9 percent, respectively.\nAt October 31, 1993, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $3.025 billion. Included in the total credit lines are three long-term credit agreements expiring on various dates through March 1996 for an aggregate maximum amount of $3.016 billion. At October 31, 1993, $2.265 billion of the lines of credit were unused. For the purpose of computing unused credit lines, the aggregate of total short-term borrowings, excluding the current portion of long-term borrowings, of the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada) were considered to constitute utilization. Annual facility fees on the credit agreements are paid by Deere & Company and charged to the Capital Corporation based on utilization.\nAt October 31, 1993, the Capital Corporation had no borrowings outstanding under the credit agreements. These agreements require the Capital Corporation to maintain its consolidated ratio of earnings before fixed charges to fixed charges at no less than 1.05 to 1 for each fiscal quarter. In addition, the Capital Corporation's ratio of senior debt to total stockholder's equity plus subordinated debt may not be more than 8 to 1 at the end of any fiscal quarter. For purposes of these calculations, \"earnings\" consist of income before income taxes to which are added fixed charges. \"Fixed charges\" consist of interest on indebtedness, amortization of debt discount and expense, an estimated amount of rental expense under capitalized leases which is deemed to be representative of the interest factor and rental expense under operating leases. \"Senior debt\" consists of the Company's total interest-bearing obligations, excluding subordinated debt, but including borrowings from Deere & Company. The Company's ratio of earnings to fixed charges was 1.99 to 1 (excluding the effect of the accounting changes), 1.74 to 1 and 1.48 to 1 in 1993, 1992 and 1991, respectively. The Company's ratio of senior debt to total stockholder's equity plus subordinated debt was 2.2 to 1 at October 31, 1993 compared with 2.7 to 1 at October 31, 1992.\nIn common with other large finance and credit companies, the Company actively manages the relationship of the types and amounts of its funding sources to its receivable and lease portfolios in an effort to diminish risk due to interest rate and currency fluctuations, while responding to favorable competitive and financing opportunities. Accordingly, from time to time, the Company has entered into interest rate swap and interest rate cap agreements to hedge its interest rate exposure in amounts corresponding to a portion of its short-term borrowings. At October 31, 1993 and 1992, the total notional principal amounts of interest rate swap agreements were $510 million and $150 million having rates of 3.6 to 9.6 percent terminating in up to 28 months and 14 months, respectively. The total notional principal amounts of interest rate cap agreements at October 31, 1993 and 1992 were $44 million and $105 million having capped rates of 8.0 percent to 9.0 percent terminating in up to 15 months and 28 months, respectively. The differential to be paid or received on all swap and cap agreements is accrued as interest rates change and is recognized over the lives of the agreements. The credit and market risk under these agreements is not considered to be significant. The estimated fair value and carrying value of these interest rate swap and cap agreements were not significant at October 31, 1993.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 5 LONG-TERM BORROWINGS\nLong-term borrowings of the Capital Corporation at October 31 consisted of the following in millions of dollars:\nIn 1993, the Capital Corporation issued $150 million of 5% notes due in 1995 and $200 million of 4-5/8% notes due in 1996. The Capital Corporation also retired $150 million of 7.4% notes due in 1993, $125 million of 9.0% debentures due in 1993 and $47 million of 7-1/2% debentures due in 1998. During 1993, the Capital Corporation issued $337 million and retired $176 million of medium-term notes. In November 1993, the Capital Corporation announced that on January 4, 1994 it will redeem the $40 million balance of outstanding 9.35% subordinated debentures due 2003.\nThe Capital Corporation has entered into interest rate swap agreements with independent parties that change the effective rate of interest on certain long-term borrowings to a variable rate based on specified United States commercial paper rate indices. The table reflects the effective year-end variable interest rates relating to these swap agreements. The notional principal amounts and maturity dates of these swap agreements are the same as the principal amounts and maturities of the related borrowings. In addition, the Capital Corporation has interest rate swap agreements corresponding to a portion of its fixed rate long-term borrowings. At October 31, 1993, the total notional principal amount of these interest rate swap agreements was $347 million, having variable rates of 3.4 percent to 3.8 percent, terminating in up to 40 months. The Capital Corporation also has interest rate swap and cap agreements associated with medium-term notes. The table reflects the interest rates relating to these swap and cap agreements. At October 31, 1993 and 1992, the total notional principal amounts of these swap agreements were $138 million and $110 million, terminating in up to 42 months and 54 months, respectively. At October 31, 1993 and 1992, the total notional principal amounts of these cap agreements were $25 million and $125 million, terminating in up to 22 months and 34 months, respectively. A Swiss franc to United States dollar currency swap agreement is also associated with the Swiss franc bonds in the table. The credit and market risk under these agreements is not considered to be significant.\nAt October 31, 1993, the total estimated fair value of the Company's total long-term borrowings was $1.496 billion. The corresponding carrying amount of total long-term borrowings was $1.478 billion. Fair values of long-term borrowings with fixed rates were based on a discounted cash flow model. Fair values of long-term borrowings, which have been swapped to current variable interest rates, approximate their carrying amounts. The estimated fair value and carrying value of the Company's interest rate swap and cap agreements associated with medium-term notes were not significant at October 31, 1993.\nThe approximate amounts of long-term borrowings maturing and sinking fund payments required in each of the next five years, in millions of dollars, are as follows: 1994-$405, 1995-$633, 1996-$262, 1997-$309, 1998-$11.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 FIXED CHARGE COVERAGE\nDeere & Company has expressed an intention of conducting its business with the Company on such terms that the Company's consolidated ratio of earnings before fixed charges to fixed charges will not be less than 1.05 to 1 for each fiscal quarter. Financial support was not provided in 1993, 1992 or 1991, as the ratios were 1.99 to 1 (excluding the effect of the accounting changes), 1.74 to 1, and 1.48 to 1, respectively. This arrangement is not intended to make Deere & Company responsible for the payment of obligations of the Company.\nNOTE 7 COMMON STOCK\nAll of the Company's common stock is owned by John Deere Credit Company, a wholly-owned finance holding subsidiary of Deere & Company. No shares of common stock of the Company were reserved for officers or employees or for options, warrants, conversions or other rights at October 31, 1993 or 1992.\nNOTE 8 DIVIDENDS\nIn October 1993, the Capital Corporation paid a cash dividend to John Deere Credit Company of $82 million, which in turn paid an $82 million cash dividend to Deere & Company. Similarly, during 1992, the Capital Corporation paid a $70 million dividend. During the first quarter of 1994, the Capital Corporation declared and paid a dividend of $150 million to John Deere Credit Company, which in turn declared and paid a dividend of $150 million to Deere & Company.\nNOTE 9 PENSION AND OTHER RETIREMENT BENEFITS\nThe Company participates in the Deere & Company salaried pension plan, which is a defined benefit plan in which benefits are based primarily on years of service and employees' compensation near retirement. This plan is funded according to the 1974 Employee Retirement Income Security Act (ERISA) and income tax regulations. Plan assets consist primarily of common stocks, common trust funds, government securities and corporate debt securities. Pension expense is actuarially determined based on the Company's employees included in the plan. The Company's pension expense amounted to $1.5 million in 1993, $1.0 million in 1992 and was negligible in prior years. Further disclosure for the plan is included in the Deere & Company 1993 annual report pension note.\nDuring the fourth quarter of 1993, the Company adopted FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, effective November 1, 1992. Additional information is presented in the \"Summary of Significant Accounting Policies\" on page 35, and the \"Quarterly Data (unaudited)\" on page 45.\nThe Company generally provides defined benefit health care and life insurance plans for retired employees. Health care and life insurance benefits expense is actuarially determined based on the Company's employees included in the plans and amounted to $.6 million in 1993. The 1992 and 1991 expenses were negligible as determined under the previous accounting principle.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10 INCOME TAXES\nTAXES ON INCOME AND INCOME TAX CREDITS The taxable income of the Company is included in the consolidated United States income tax return of Deere & Company. Provisions for income taxes are made generally as if the Capital Corporation and each of its subsidiaries filed separate income tax returns.\nDEFERRED INCOME TAXES In 1992, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. There was no cumulative effect of adoption or current effect on continuing operations mainly because the Company had previously adopted FASB Statement No. 96, Accounting for Income Taxes, in 1988. Deferred income taxes arise because there are certain items that are treated differently for financial accounting than for income tax reporting purposes. An analysis of deferred income tax assets and liabilities at October 31 in millions of dollars follows:\nThe provision for income taxes consisted of the following in millions of dollars:\nThe Omnibus Budget Reconciliation Act of 1993, which enacted an increase in the United States federal statutory income tax rate effective January 1, 1993, was signed into law during the fourth quarter of 1993. In accordance with FASB Statement No. 109, Accounting for Income Taxes, deferred tax assets and liabilities as of the enactment date were revalued during the fourth quarter of 1993 using the new rate of 35 percent. This resulted in a credit of $.7 million to the provision for income taxes.\nEFFECTIVE INCOME TAX PROVISION A comparison of the statutory and effective income tax provisions of the Company and reasons for related differences follow in millions of dollars:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11 CASH FLOW INFORMATION\nFor purposes of the statement of consolidated cash flows, the Company considers investments with original maturities of three months or less to be cash equivalents. Substantially all of the Company's short-term borrowings mature within three months or less.\nCash payments by the Company for interest incurred on borrowings in 1993, 1992 and 1991 were $134.8 million, $172.6 million and $215.9 million, respectively. Cash payments for income taxes during these same periods were $54.9 million, $53.0 million and $53.3 million, respectively.\nNOTE 12 LEGAL PROCEEDINGS\nThe Company is subject to various unresolved legal actions which arise in the normal course of its business. The most prevalent of such actions relates to state and federal regulations concerning retail credit. There are various claims and pending actions against the Company with respect to commercial and consumer financing matters. These matters include lawsuits pending in federal and state courts in Texas alleging that certain of the Company's retail finance contracts for recreational vehicles and boats violate certain technical provisions of Texas consumer credit statutes dealing with maximum rates, licensing and disclosures. The plaintiffs in Texas claim they are entitled to common law and statutory damages and penalties. On November 6, 1992 the federal District Court certified a federal class action under Rule 23 (b) (3) of the Federal Rules of Civil Procedure in an action brought by Russell Durrett, individually and on behalf of others, against John Deere Company (filed in state court on February 19, 1992 and removed on February 26, 1992 to the United States District Court for the Northern District of Texas, Dallas Division). On October 12, 1993, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992, the 281st District Court for Harris County, Texas, certified a class under Rules 42 (b) (1) (A), 42 (b) (1) (B) and 42 (b) (2) of the Texas Rules of Civil Procedure, of all persons who opt out of the federal class action. The Company believes that it has substantial defenses and intends to defend the actions vigorously. Although it is not possible to predict the outcome of these unresolved legal actions, and the amounts of claimed damages and penalties are large, the Company believes that these unresolved legal actions will not have a material adverse effect on its consolidated financial position.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13 QUARTERLY DATA (UNAUDITED)\nSupplemental consolidated quarterly information for the Company follows in millions of dollars:\nSchedule VIII\nJOHN DEERE CAPITAL CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED OCTOBER 31, 1993, 1992 AND 1991 (in thousands of dollars)\nSchedule IX\nSHORT-TERM BORROWINGS FOR THE YEARS ENDED OCTOBER 31, 1993, 1992 AND 1991 (in thousands of dollars)\n- ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------\nINDEX TO EXHIBITS\nPage No. -------\n3.1 Certificate of Incorporation, as amended 50\n3.2 By-laws, as amended 57\n4.1 Credit agreements among registrant, Deere & Company, various financial institutions, and Chemical Bank and Deutsche Bank, as Managing Agents, dated as of December 15, 1993. 64\n4.2 Revolving evergreen facility linked credit agreement among registrant, Deere & Company and a number of banks dated as of March 26, 1993 (Exhibit 4.2 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n4.3 Form of certificate for common stock (Exhibit 4.3 to Form 10-Q of the registrant for the quarter ended April 30, 1993*)\n4.4 Indenture dated as of February 15, 1991 between registrant and Citibank, N.A., as Trustee (Exhibit 4.5 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\nCertain instruments relating to long-term debt constituting less than 10% of the registrant's total assets, are not filed as exhibits herewith pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. The registrant will file copies of such instruments upon request of the Commission.\n9. Not applicable.\n10.1 Agreement dated May 11, 1993 between registrant and Deere & Company concerning agricultural retail notes (Exhibit 10.1 to Form 10-Q of registrant for the quarter ended April 30, 1993*).\n10.2 Agreement dated May 11, 1993 between registrant and Deere & Company concerning lawn and grounds care retail notes (Exhibit 10.2 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.3 Agreement dated May 11, 1993 between registrant and John Deere Industrial Equipment Company concerning industrial retail notes (Exhibit 10.3 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.4 Agreement dated January 26, 1983 between registrant and Deere & Company relating to agreements with United States sales branches on retail notes (Exhibit 10.4 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n10.5 Insurance policy no. CL-001 of Sierra General Life Insurance Company providing insurance on lives of purchasers of certain equipment financed with receivables (Exhibit 10.5 to Form 10-Q of the registrant for the quarter ended April 30, 1993*).\n11. Not applicable.\n12. Statement of computation of the ratio of earnings before fixed charges to fixed charges for each of the five years in the period ended October 31, 1993. 321\n13. Not applicable\n16. Not applicable\n18. Not applicable\n21. Omitted pursuant to instruction J(2)\n22. Not applicable\n23. Consent of Deloitte & Touche 322\n24. Not applicable\n27. Not applicable\n28. Not applicable\n99.1 Parts I and II of the Deere & Company Form 10-K for the fiscal year ended October 31, 1993.*\n- ----------------------------- * Incorporated by reference. Copies of these exhibits are available from the Company upon request."},"word_count":{"kind":"number","value":16470,"string":"16,470"},"character_count":{"kind":"number","value":106300,"string":"106,300"}}},{"rowIdx":281,"cells":{"filename":{"kind":"string","value":"79209_1993.txt"},"id":{"kind":"string","value":"79209_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"79209"},"text":{"kind":"string","value":"ITEM 1. BUSINESS.\nPLY GEM Industries, Inc., a Delaware corporation (\"Ply Gem\", hereinafter with its subsidiaries referred to collectively as the \"Company\"), was originally incorporated in 1946 in New York and reincorporated in Delaware in 1987. The Company is a leading manufacturer and distributor of a wide range of specialty products for the home improvement industry. The Company believes that it is among the nation's largest manufacturers of wood windows, vinyl siding and accessories, and vinyl windows, and one of the major suppliers of specialty wood and other related products. Each of the Company's ten wholly- owned subsidiaries and its one division have achieved a leading market position within their respective niches of the home improvement industry.\nThe home improvement industry includes products designed for all remodeling, repair and alteration of residential structures, whether the work is performed by the homeowner (the \"do-it-yourselfer\" or \"D-I-Y\"), or by a professional contractor. Home improvement products, which in some cases are also used in new construction applications, are sold either through retailers or specialty wholesale distributors that in turn sell to retailers, contractors and builders. The success of the recently introduced warehouse home center format, such as that utilized by Home Depot, continues to change the traditional way in which home improvement products are sold.\nThe Company's primary objective is to become the supplier of choice to the home improvement industry for high margin specialty products. The Company believes that it is uniquely positioned to provide products and services to the major home center retailers, which the Company believes is the fastest growing segment of the home improvement industry.\nThe Company's products are distributed through an extensive network which includes major retail home center chains, specialty home remodeling distributors, lumber and building products wholesalers, professional contractors and Company operated distribution centers. The products are marketed throughout the United States, Canada and Puerto Rico through Company sales personnel and independent representatives.\nThe Company operates predominantly in one business segment -- Home Improvement Products. Prior to 1992, the Company reported in two industry segments, Home Improvement Products and Home Products. The operations of the latter segment, consisting of manufacturing and distribution of disposable paper and cloth vacuum cleaner bags, have become less significant over the past several years and as a result the Home Products operations are not material to an understanding of the Company's business taken as a whole.\nBUSINESSES OF THE COMPANY\nThe Company operates in four primary business groups: Windows, Doors and Siding; Specialty Wood Products; Distribution; and Home Products. Set forth below are the operating entities within each group and the year in which the entity was acquired by the Company. Ply*Gem Manufacturing is a division of the Company and constitutes the Company's original business.\nWINDOWS, DOORS AND SIDING\nSNE Enterprises, Inc: SNE is a major manufacturer of wood windows, competing with companies such as Andersen, Marvin and Pella. The Company believes that it is the second largest supplier of wood windows to the major home center retailers.\nSNE manufactures a full line of wood windows and patio doors, glass and polycarbonate skylights, and wooden interior bifold doors and shutters. Its products are sold under the Crestline(R) and Vetter(R) brand names and include double hung, casement, sliding and awning windows as well as hinged and sliding patio doors. SNE will shortly introduce a window that offers the maintenance free and insulating benefits of a solid vinyl window yet has a wood interior that can be painted or stained. SNE's windows are available primed, or with an exterior cladding of either aluminum or vinyl. They are available in both custom and stock sizes, and are sold through an extensive network of home centers, lumber and building materials retailers, and specialized value added distributors. SNE's products are primarily for the home improvement market.\nThe market for wood windows is highly competitive. SNE differentiates itself from its competition by pursuing a dual brand strategy, having a distribution base in both the remodeling and new construction markets, extensive custom design and manufacturing capabilities, and a superior field service and support network. In addition, SNE's strategy of manufacturing window components at its main facility in Central Wisconsin for final assembly at one of four strategically located assembly/distribution centers, allows for the delivery of product to customers on a just-in-time basis. The Company believes that SNE will continue to grow as its existing products gain brand recognition from cooperative and other advertising programs with its retail customers, and as it introduces new products. Furthermore, SNE is exploring opportunities to expand its business into new geographic markets.\nVariform, Inc.: Variform is a producer of vinyl siding in the United States and a leading supplier to the major home center retailers. Its vinyl siding, soffit and accessories are produced in a variety of patterns and colors, including woodgrains. Vinyl siding is used in both remodeling and new construction applications and has captured an increasing share of the market for exterior siding materials (which primarily includes wood, aluminum and masonry) due to its ease of installation, durability and low maintenance requirements.\nVinyl siding is sold to either specialized wholesale distributors who in turn sell directly to remodeling contractors (one-step distribution), or to building materials distributors who sell to home centers and lumberyards who in turn sell to remodeling contractors (two-step distribution). While Variform sells through both channels of distribution, it focuses on the two-step market, where management believes it is a dominant supplier to the major home center retailers and retail lumber yards. The Company believes that Variform is able to compete on favorable terms as a result of its broad distribution coverage, high quality innovative products, and production efficiency. Additionally, Variform is strongest in the retail segment of the market,\nwhich continues to grow at a rate that is faster than the overall market, as warehouse retailers continue to take business away from the traditional one- step market by offering remodeling contractors a \"one-stop-shop\" for all of their home improvement materials needs.\nGreat Lakes Window, Inc.: Great Lakes is a manufacturer of high quality, energy efficient, maintenance free vinyl replacement windows. Its products include double hung, casement, sliding and awning windows as well as hinged and sliding patio doors. Great Lakes offers a wide selection of products, including a variety of exterior colors and interior woodgrains, several different grille patterns and a wide assortment of glass options. Great Lakes products are primarily used in replacement applications, where windows and patio doors are manufactured for a specific order on a custom size basis. Accordingly, Great Lakes maintains relatively little finished goods inventory. Great Lakes has recently introduced a vinyl window to penetrate the new construction market which will be sold primarily through two-step distribution.\nGreat Lakes sells its products through its highly trained sales force. It sells its products to specialty window distributors who in turn sell to remodeling contractors, and direct to large remodeling companies. The Company believes that Great Lakes is able to compete successfully due to the breadth and quality of its product offering, and its merchandising support that the Company believes is one of the best in the industry. In addition, Great Lakes has been the forerunner in introducing new designs to the industry. Great Lakes' innovative locking system, interior woodgrains and its use of various glass treatments, are a few examples of innovations that distinguish Great Lakes from its competition. Great Lakes expects to continue to develop new designs and features for its products in the future.\nRichwood Building Products, Inc.: Richwood is a manufacturer of siding accessories to the remodeling and new construction markets. Siding accessories include blocks, which allow for the flush mounting of items like light fixtures to the exterior of a home, and gable vents. Their products are sold through a network of manufacturers representatives and directly to home centers, lumberyards and wholesale distributors of building materials, electrical and plumbing products. Richwood is the only manufacturer of siding accessories to offer a color selection that matches the colors offered by most, if not all, major manufacturers of vinyl siding in the United States and Canada.\nSPECIALTY WOOD PRODUCTS\nHoover Treated Wood Products, Inc: Hoover is a producer of pressure treated wood products, selling to home center chains, lumberyards and building materials retailers and wholesalers. Its products include lumber and plywood which have been treated for fire retardancy and for protection against moisture and insect infestation.\nSagebrush Sales, Inc.: Sagebrush is a manufacturer and distributor of specialty lumber and building products serving the home improvement and building materials markets in the Southwest.\nGoldenberg Group, Inc.: Goldenberg is a West Coast manufacturer and distributor of furniture components, laminates and board products to furniture manufacturers and other original equipment manufacturers, building material retailers and wholesalers.\nPly*Gem Manufacturing is a manufacturer and distributor of decorative wall coverings. Its products include decorator paneling, planking and tileboard for the home improvement market. Ply Gem Manufacturing recently introduced a complete line of imported ceramic, porcelain and marble floor tile marketed through home centers and lumber yards.\nContinental Wood Preservers, Inc.: Continental is a Midwestern manufacturer of pressure treated wood products for home improvement retailers and lumberyards in the Midwest.\nWhile the specialty wood products industry is very competitive, the Company believes it is able to compete effectively by providing superior customer service, outstanding quality and, wherever possible,\nproprietary products. The companies within the group focus on high margin, niche markets within the broader defined wood products industry which tends to be commodity driven. Its products are sold through home center retailers and wholesalers of building materials. The Company believes that growth of this segment of its business will result from continued expansion of its share of the growing home center market.\nDISTRIBUTION\nAllied Plywood Corporation: Allied is a national distributor of a broad range of high end specialty wood and wood related products, including hardwood plywood, melamine and other laminated board products, hardwood lumber, solid surface materials and cabinet hardware. It is also a major importer of Russian wood products, through its affiliate, Russian Wood Express Inc. (\"Russian Wood\"). Allied's customers are industrial woodworkers, including cabinet manufacturers, architectural millworkers, and manufacturers of store fixtures, furniture, signs and exhibits. Allied sells its products through an extensive network of twelve company operated warehouse facilities and utilizes numerous public warehouses located in various major port cities. Sales are generated by a well trained and experienced sales force.\nAllied differentiates itself from its competitors, which primarily include local independent distributors, by its superior customer service, geographic coverage and breadth of product line. As a result, it has become a preferred distributor of many products, selling them on an exclusive, or limited exclusive, basis.\nThe Company believes that Allied's future growth will be from the introduction of new products, expansion of its customer base and the development of further opportunities through Russian Wood. Allied recently began to penetrate the retail home center market with some of its products and, the Company believes, will increase its sales to that industry segment.\nHOME PRODUCTS\nStudley Products, Inc.: Studley is a manufacturer of disposable cloth and paper vacuum cleaner bags. In addition, it sells related floor care products, grass catcher bags for the lawn care market, and filtration products for use in pollution control applications. Studley's products are sold to manufacturers of vacuum cleaners, mass merchandisers and other retailers and recently to the retail home center market and other retailers.\nEven though the market is very competitive, Studley is able to compete on the basis of its technical expertise in the design and manufacture of its products, and in its use of high performance materials. Studley recently introduced an innovative new vacuum cleaner bag that is able to capture pollen and other allergy causing bacteria through the use of high performance materials. The continued introduction of new products and the fact that many consumers are now likely to own more than one vacuum cleaner are expected to provide opportunities for future growth.\nPRODUCTION AND FACILITIES\nThe Windows, Doors and Siding group operates fifteen manufacturing and warehouse facilities in the United States and one in Canada. Vinyl siding is produced by an extrusion process which forms siding through various dies from certain resin compounds, primarily polyvinyl chloride. Siding accessories are manufactured through an injection molding process using proprietary mold designs. Insulated vinyl framed replacement windows are manufactured, using a patented process, from insulated glass and vinyl extrusions. The manufacturing process of wood windows and patio doors involves cutting and shaping of components that are assembled with high speed tools. Final assembly of most wood window and door products takes place in four distribution centers located in the Eastern and Midwestern United States. The manufacturing plants generally operate in a \"make-to-order\" environment. In 1993, Variform completed construction of a 75,000 square foot vinyl siding manufacturing facility in Jasper, Tennessee and Great Lakes completed a 90,000 square foot plant expansion at its vinyl window manufacturing facility in Toledo, Ohio.\nThe Specialty Woods group operates thirteen manufacturing and warehouse facilities in the United States. The treatment process of wood products generally involves vacuum pressure impregnation of chemicals into the wood in an enclosed vessel to ensure thorough penetration to meet industry and government standards. Some of the wood is kiln dried after treatment to remove moisture imparted during the pressure impregnation process, providing a clean, dry and easily handled product. The Company's high-speed laminating production facilities in Gloucester City, New Jersey afford flexibility in laminating paper and vinyl to various substrate materials. Furniture components are manufactured from particle board or fiberboard which is machined to customer specifications. Several unique proprietary processes are employed to manufacture these products efficiently. Specialty lumber products, including siding, decking and paneling are manufactured by the Company in three facilities with a combined annual production capacity in excess of 100 million board feet.\nDistribution operates twelve distribution centers located primarily in the East and utilizes numerous public warehouses located in various major port cities.\nDisposable and cloth vacuum cleaner bags are manufactured at two facilities in the United States and one in Canada. Disposable paper vacuum cleaner bags are manufactured on highly automated equipment, the major part of which was designed and built by the Company. Cloth vacuum cleaner bags are manufactured by cutting fabric to a preformed pattern which is then sewn into the finished product and packaged. The Company is continuously engaged in designing vacuum cleaner bags for new vacuum cleaner models.\nRAW MATERIALS\nThe principal raw materials used in the manufacture of the Company's products are polyvinyl chloride, polypropylene, glass, vinyl extrusions, particle board, fiberboard, plywood, various species of lumber such as pine, spruce, luaun, hemlock and fir, various chemicals, filter paper, woven and non woven fabric, and paper.\nThe Company purchases its raw materials from a large number of domestic and international sources. The Company believes that there are alternative sources of supply in the event of its inability to purchase from its present suppliers.\nSEASONALITY\nThe Company's home improvement business is seasonal, particularly in the Northeast and Midwest regions of the United States where inclement weather during the winter months usually reduces the level of activity in both the home improvement and new construction markets. The Company's lowest sales levels usually occur during the first and fourth quarters. Since a high percentage of the Company's manufacturing overhead and operating expenses are relatively fixed throughout the year, operating income tends to be lower in quarters with lower sales. Inventory and borrowings to satisfy working capital requirements are usually at their highest level during the second and third quarters.\nBACKLOG\nIn general, the Company does not produce against a backlog of firm orders; production is geared primarily to the level of incoming orders and to projections of future demand. Significant inventories of finished goods, work- in-process and raw materials are maintained to meet delivery requirements of customers.\nHoover and Continental maintain a steady backlog of firm orders to be filled in an amount representing approximately 7% of their annual sales. Distribution consists of warehouse operations where orders are filled from stock and where there is no significant backlog.\nEMPLOYEES\nOn January 3, 1994, Monte R. Haymon became President, Chief Operating Officer and a member of the Board of Directors of Ply Gem. Prior to joining Ply Gem, Mr. Haymon was President and Chief Executive Officer of a $2 billion manufacturing company. Mr. Haymon has over 20 years of experience in successfully managing multiple business units and achieving outstanding financial performance.\nAt December 31, 1993 approximately 4,000 persons were employed by the Company. Approximately 1,300 of such employees are covered by collective bargaining agreements which expire at various times over the next three years. The Company has not had any significant work stoppages and considers its relations with its employees to be good.\nITEM 2.\n\n\nITEM 2. PROPERTIES.\nThe Windows, Doors and Siding group operates fifteen manufacturing and warehouse facilities in the United States and one in Canada ranging in size from approximately 20,000 square feet to 660,000 square feet. Of these facilities, nine are owned, and seven are leased under net leases that expire at various dates through 2016. The group's manufacturing facilities operated at ranges of approximately 75% to 95% of capacity during 1993.\nThe Specialty Woods group has thirteen manufacturing and warehouse facilities in the United States ranging in size from approximately 35,000 square feet to 215,000 square feet. Of these facilities, seven are owned and six facilities are leased under net leases that expire at various dates through 2005. The group's manufacturing facilities operated at ranges of approximately 55% to 90% of capacity during 1993.\nDistribution operates twelve distribution centers located primarily in the East ranging in size from approximately 16,000 square feet to 70,000 square feet. Two facilities are owned and ten facilities are leased under leases that expire at various dates through 1998.\nHome Products has two manufacturing facilities in the United States and one in Canada. These facilities range in size from approximately 39,000 square feet to 160,000 square feet and are leased by the company under leases that expire at various dates through 2007. The facilities operated at ranges of approximately 60% to 65% of capacity during 1993.\nThe Company's building, machinery and equipment have been generally well maintained, are in good operating condition and are adequate for current and future production requirements.\nThe Company's executive offices are located at 777 Third Avenue, New York, New York and consist of 9,500 square feet of office space which is leased through 1999.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS.\nHoover, a wholly-owned subsidiary of Ply Gem, is a defendant, along with many other parties, in a number of commercial lawsuits, including a purported class action on behalf of certain Maryland homeowners, alleging property damage caused by alleged defects in certain pressure treated interior wood products it produced and sold through August, 1988. Sales of this product constituted less than 3% of the total sales of Ply Gem and its subsidiaries on a consolidated basis during the period January 1, 1984 through December 31, 1990. Ply Gem is also a defendant in many of these suits. The number of lawsuits pending as of December 31, 1993, as well as the number of lawsuits filed in 1993, has declined significantly.\nMany of the suits and claims have been settled. In those suits that remain pending, direct defense costs are being paid by either insurance carriers, under reservations of rights agreements, or out of insurance proceeds. Two actions have proceeded to trial against Hoover and resulted in jury verdicts against it. In one of these actions, judgment was entered in Hoover's favor by the court after a jury verdict against it and the plaintiff's petition to appeal from the judgment entered in Hoover's favor has been denied. Hoover is appealing the other judgment and believes that it has meritorious grounds for overturning it in whole or in part. Certain\ncarriers have brought actions challenging coverage. Hoover and Ply Gem believe they have meritorious claims for coverage, are defending these actions, have counterclaimed and are seeking declaratory judgments confirming coverage. Many of the coverage claims have been settled and proceeds from those settlements, along with the proceeds from a settlement of claims by Hoover against certain suppliers of materials used by it in the production of treated wood, are available for the settlement of the underlying property damage actions, including the jury verdict now on appeal. Hoover believes that its remaining coverage disputes will be resolved and a substantial amount of additional coverage will be available to it.\nHoover and Ply Gem are vigorously defending those lawsuits which cannot be resolved on a reasonable basis and believe that they have meritorious defenses to those suits including, in the case of Ply Gem, the defense that it has been improperly joined, as it did not manufacture or market the Hoover products at issue, and is not legally liable for the damage allegedly caused by them.\nIn evaluating the effect of the lawsuits, a number of factors have been considered, including: the number and exposure posed by the pending lawsuits; the significant decline in the number of lawsuits filed in 1993; the availability of various legal defenses, including statutes of limitation, the existence of settlement protocols, an agreement indemnifying Hoover as to certain past and future claims and Hoover's experience in settling with its insurance companies and the likely availability of additional insurance. It is estimated that the future cost of resolving those matters not presently covered by existing settlements with insurance carriers and suppliers is sixteen million dollars, which it expects will be covered by future recoveries from additional insurance carriers. Based on its evaluation, the Company believes that the ultimate resolution of the lawsuits and the insurance claims will not have a material adverse effect upon the financial position of the Company.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNONE\nPART II\nITEM 5.\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock is listed on the American Stock Exchange. The following table sets forth, for the periods indicated, the high and low market prices and dividends paid.\nThe Company has paid cash dividends on its Common Stock since 1976 and presently pays quarterly dividends at the annual rate of $.12 per share.\nThe Company's revolving credit facility has limitations on the annual amounts of the Company's dividends. Under the most restrictive provision, at December 31, 1993, approximately $2,192,000 was available for the payments of dividends in 1994.\nThe number of stockholders of record of the Company's common stock as of March 14, 1994 was 2,910.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA.\nSet forth below is certain Selected Financial Data for each of the years shown.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company's consolidated results of operations and financial condition. The discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto.\nRESULTS OF OPERATIONS\nNET SALES\nThe Company achieved record net sales during 1993 of $722.7 million, an increase of approximately $100 million or 16.0% over 1992 net sales of $623.2 million and an increase of approximately $161 million or 28.7% over 1991 net sales of $561.6 million. Sales in each of the Company's 1993 quarters were above those of comparable 1992 periods.\nSubstantially all operating entities of the Company reported higher net sales for 1993 when compared with 1992. Of the total net sales increase in 1993, approximately 10% is attributable to additional unit volume and approximately 6% to increases in average selling prices. The increase in net sales in 1992, as compared with 1991, was primarily related to additional unit volume.\nStrong sales in the Company's Windows, Doors, and Siding group continue to fuel the Company's growth as this group has achieved double digit sales growth in each of the last five years.\nAfter several years of decline, due primarily to the closing and consolidation of certain facilities and elimination of certain lower margin product lines, Distribution reported substantial improvement in 1993, as net sales were 19% higher than 1992.\nGROSS PROFIT\nGross profit, expressed as a percentage of net sales, was 19.1% in 1993, compared with 20.7% for 1992 and 21.5% in 1991. Higher raw material costs (particularly wood and resin), competitive pricing pressures, and costs of introducing new products accounted for most of the decline in 1993. The lower margin in 1992 as compared to 1991 was due primarily to higher wood costs.\nThe Company's results of operations are affected by fluctuations in the market prices of lumber and other wood products that have been used as raw materials in its various manufacturing operations. During the last several years, the market prices of lumber and other wood products have been volatile. Although the Company attempts to increase the sales price of its products in response to higher lumber and wood products costs, such sales price increases often lag behind the escalation in the cost of the raw materials in question. While the Company intends to increase prices in a timely manner to cover any further increases in the cost of lumber and other wood products, its ability to do so may be limited by competitive or other factors.\nThe Company continues to explore various strategies to improve its gross profit margins, including productivity enhancements, increased yields through more efficient process technologies, cost reduction programs, and reviews of manufacturing capacity and utilization.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES\nSelling, general and administrative expenses, as a percentage of net sales, were 14.8% in 1993, compared to 16.3% in 1992 and 16.9% in 1991. The improvement reflects the Company's continued progress in its ongoing efforts to manage expense growth relative to revenue growth.\nThe significant improvement in 1993 and 1992 was primarily due to economies resulting from the absorption of fixed expenses over a larger sales base.\nINCOME FROM OPERATIONS\nIncome from operations increased 15.5% to $31.6 million in 1993 from $27.4 million in 1992. Income from operations was $25.8 million in 1991. The improvements are due to the factors discussed above.\nINTEREST EXPENSE\nInterest expense was $10.1 million in 1993 compared to $9.6 million in 1992 and $14.1 million in 1991. The slight increase during 1993 as compared to 1992 is due primarily to higher average debt balances outstanding during 1993. Lower interest rates, coupled with lower average debt outstanding during 1992, favorably affected interest expense in 1992 by $4.5 million as compared to 1991.\nIn February 1994, the Company refinanced substantially all of its bank debt, as more fully explained in Note 7 to the Consolidated Financial Statements and in the Liquidity and Capital Resources discussion below. Pricing under the new credit facility is expected to be substantially similar to pricing under the prior facilities.\nIn March 1994, as more fully explained in Note 8 to the Consolidated Financial Statements, holders of the Company's 10% Convertible Senior Subordinated Discount Debentures (\"Debentures\") converted a total principal amount of approximately $50 million into 2,751,349 shares of the Company's common stock. As a result of this transaction, the Company will save, on an annual basis, $5 million of interest costs.\nOTHER INCOME (EXPENSE)\nOther income (expense) for 1993 and 1992 primarily includes the costs associated with the sale of receivables program, partially offset in 1993 by a gain resulting from an involuntary conversion of property.\nINCOME TAXES\nThe effective income tax rate was 44.8% in 1993, 44.6% in 1992, and 47.9% in 1991. During 1993 the federal statutory rate was increased by 1% retroactive to January 1, 1993. The rate increase was offset by a proportionately lower amount of non-deductible goodwill amortization in 1993 as compared to income before taxes in 1992 and 1991. The higher tax rate in 1991 is primarily due to operating losses of the Distribution subsidiaries for which no state tax benefits were available.\nNET INCOME\nNet income advanced 53% to $9.7 million in 1993 from $6.3 million in 1992. Net income was $4.0 million in 1991. The factors cited above were responsible for the significantly improved results of the Company.\nThe results for 1993 featured a strong operating performance by the Company's business groups. The Company's continuing success in the home improvement industry is primarily attributable to an uncompromising emphasis on quality, excellence in customer service, and superior product design.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial position remained strong in 1993.\nIn February 1994, the Company entered into a five-year revolving credit facility (\"Credit Facility\") with a syndicate of banks, which provides financing of up to $200 million. Initial borrowings were used to repay amounts outstanding under the Company's previous credit facilities. The Credit Facility provides the Company with financing at competitive prices, strengthens its balance sheet by extending debt maturities to 1999, and makes available additional resources for its Teamwork 90s internal growth programs. See Note 7 to the Consolidated Financial Statements for additional information concerning the Credit Facility.\nAs discussed above, holders of the Debentures converted a total principal amount of approximately $50 million into 2,751,349 shares of the Company's common stock. As a result, the Company's net worth will be increased by approximately $50 million, and the Company will save $5 million of annual interest expense.\nThe table below summarizes the Company's cash flow from operating, investing, and financing activities as reflected in the Consolidated Statement of Cash Flows.\nOPERATING ACTIVITIES\nThe amount of cash provided by operating activities in 1993 was relatively unchanged from 1992. The significant increase in 1991 in cash from operating activities as compared to 1992 resulted from the proceeds from the sale of certain accounts receivable to a financial institution and to the success of the Company's inventory reduction program.\nThe Company's working capital requirements for inventory and receivables are impacted by changes in raw materials costs, the availability of raw materials, growth of the Company's businesses and seasonality. As a result, such requirements may fluctuate significantly.\nINVESTING ACTIVITIES\nInvesting activities of the Company during the discussion periods primarily consist of the acquisition and sale of property, plant and equipment and the receipt and usage of funds held for construction.\nDuring 1992, Variform began construction of a new vinyl siding facility in Jasper, Tennessee and Great Lakes commenced a plant expansion at its facility in Toledo, Ohio. Aggregate construction and initial production equipment costs, which are being financed from the proceeds of industrial revenue bonds, are $11.2 million. The Jasper facility was completed during the second quarter of 1993 and the Toledo facility during the third quarter of 1993.\nCapital expenditures (excluding approximately $9.6 million of costs incurred through December 31, 1993, of which $4.8 million was incurred during 1993 for the aforementioned construction projects) were $15.7 million in 1993, compared to $12.3 million in 1992 and $9.7 million in 1991. Most of the outlays were for machinery and equipment used to expand capacity and improve productivity.\nFunds Held for Construction relate to proceeds and usage of cash from the industrial development revenue obligations discussed above.\nFixed asset acquisitions provide a basis for future growth. The Company has formalized an intensive review procedure for all capital expenditures. The acceptability of a capital project is based on many factors, including its discounted cash flow return on investment and projected payback period. The Company expects to incur approximately $15 million in 1994 for capital expenditures, excluding costs related to the construction projects discussed above.\nFINANCING ACTIVITIES\nDuring 1993 the Company had borrowings of $ 34.8 million under its revolving credit lines. Bank borrowings were primarily used to finance growth in working capital and capital expenditures.\nBALANCE SHEET CONTINUES TO BE STRONG\nThe pro forma capitalization of the Company (long-term debt plus stockholders' equity) was $277.5 million at December 31, 1993. The pro forma ratio of debt to capitalization was approximately 36% at December 31, 1993 which is substantially improved from such ratio at December 31, 1992 which was approximately 50%.\nThe current ratio was 3.2 at December 31, 1993, significantly better than the 2.3 ratio at the end of 1992. The factors that contributed to this improvement included the reduction of current debt obligations resulting from the Credit Facility, increased cash balances and higher receivables caused by increased sales. Cash and marketable securities totaled $14.4 million at December 31, 1993.\nLong-term bank debt at December 31, 1993 was $92.9 million, compared with $62.5 million at December 31, 1992. The higher debt level was needed to finance higher working capital requirements and capital expenditures.\nIn addition to cash from operating activities, the Company has a new Credit Facility available to meet future liquidity needs. After repayment of the prior credit facilities, approximately $63 million was available for borrowing under the Credit Facility. The Company has several interest rate agreements which reduce the Company's exposure to rising interest rates.\nSEASONAL NATURE OF BUSINESS\nThe home improvement business is seasonal, particularly in the Northeast and Midwest regions of the United States where inclement weather during the winter months usually reduces the level of building and remodeling activity in both the home improvement and new construction markets. The Company's lowest sales levels usually occur during the first and fourth quarters. Since a high percentage of the Company's manufacturing overhead and operating expenses are relatively fixed throughout the year, operating income tends to be lower in quarters with lower sales. Inventory and borrowings to satisfy working capital requirements are usually at their highest level during the second and third quarters.\nPROSPECTIVE FINANCIAL STANDARDS\nThe Financial Accounting Standards Board (FASB) issued Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, and FASB No. 112, Employers' Accounting for Postemployment Benefits, which are effective January 1, 1994. Adoption of these standards is not expected to have a material impact on the Company's results of operations or financial position, nor will it affect the Company's cash flows.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS (THE INDEX TO CONSOLIDATED FINANCIAL STATEMENTS IS INCORPORATED BY REFERENCE IN ITEM 14(A) OF PART IV OF THIS FORM 10-K)\n(ART)\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Directors and Stockholders Ply Gem Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Ply Gem Industries, Inc. and Subsidiaries (the \"Company\") as of December 31, 1993 and 1992, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ply Gem Industries, Inc. and Subsidiaries as of December 31, 1993 and 1992, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nGRANT THORNTON\nNew York, New York February 24, 1994 (except for Note 8 as to which the date is March 23, 1994)\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31,\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nTHREE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these statements.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Ply Gem Industries, Inc. and its wholly-owned subsidiaries after eliminating all significant intercompany accounts and transactions. Certain prior year items have been reclassified to conform to the 1993 presentation.\nCash and Cash Equivalents\nCash and cash equivalents include cash on hand and temporary investments having a maturity of three months or less.\nMarketable Securities\nMarketable securities are carried at the lower of aggregate cost or market.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined on the first-in, first-out (FIFO) method.\nProperty, Plant and Equipment\nOwned property, plant and equipment are depreciated, generally on a straight- line basis over their estimated useful lives. Leasehold improvements are amortized on a straight-line basis over their respective lives or the terms of the applicable leases, including expected renewal options, whichever is shorter. Accelerated depreciation methods are used for tax purposes. Capitalized leases are amortized on a straight-line basis over the terms of the leases or their economic useful lives.\nIntangible Assets\n(a) Patents and Trademarks\nPurchased patents and trademarks are recorded at appraised value at time of acquisition and are being amortized on a straight-line basis over their estimated remaining economic lives; thirteen to sixteen years for patents and thirty years for trademarks.\n(b) Other Intangibles\nCost in excess of net assets acquired is being amortized from twenty to thirty years on a straight-line basis and is evaluated annually to determine potential impairment by comparing its carrying value to the estimated future cash flows of the related assets. Other purchased intangibles are being amortized on a straight-line basis generally from ten to thirty-nine years.\nIncome Taxes\nDeferred income taxes are provided to reflect temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nEarnings Per Share\nEarnings per share of common stock are based on the weighted average number of shares and common equivalent shares outstanding during each of the periods. Primary and fully diluted earnings per share include the dilutive effect of unexercised stock options as modified for options in excess of 20% of shares outstanding. The assumed conversion of the Company's Convertible Subordinated Debentures was not used in the fully diluted calculation because the result would be anti-dilutive.\nNOTE 2 -- CASH FLOWS\nSupplemental cash flow information for the years ended December 31 is as follows:\nNOTE 3 -- SALE OF ACCOUNTS RECEIVABLE\nIn December 1991, the Company entered into a three-year agreement to sell, with limited recourse, up to $20 million of undivided fractional interests in a designated pool of accounts receivable. An interest in new accounts receivable are sold as collections reduce previously sold interests. At December 31, 1993 and 1992, accounts receivable were reduced $20 million by these transactions. Program costs of $1,495,000 and $1,502,000 are included in other income (expense) in the 1993 and 1992 Consolidated Statements of Income, respectively.\nNOTE 4 -- INVENTORIES\nInventories consisted of the following at December 31:\nNOTE 5 -- PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment at December 31 included:\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) NOTE 6 -- INTANGIBLE AND OTHER ASSETS\nThe accumulated amortization of cost in excess of net assets acquired and other intangible assets is $26,136,000 at December 31, 1993 and $22,022,000 at December 31, 1992.\nOther assets at December 31, 1993 include notes receivable from an executive officer of $7,280,000 ($8,220,000 at December 31, 1992) at an average interest rate of 7.1% and are due in approximately equal annual installments through 2003. Under the terms of the notes, principal and interest are forgiven upon the attainment of at least a 20% improvement in net income versus the prior year, or at the discretion of the Board of Directors. The performance goal was achieved in 1993 and 1992. Furthermore, under the terms of the officer's employment agreement the loan shall be forgiven upon the occurrence of a change in control of the Company or permanent disability.\nNOTE 7 -- LONG-TERM DEBT\nLong-term debt consists of the following:\n- -------- (a) At the Company's option, interest rates are at the prevailing prime rate and various LIBOR rates, or combinations thereof. The Company has entered into interest rate cap agreements which limit the maximum interest rates on a portion of these loans.\nOn February 24, 1994 the Company refinanced substantially all of its bank debt under a $200 million five year syndicated bank credit facility which replaced several separate bank agreements including short-term facilities. Accordingly, the table above reflects this transaction as of December 31, 1993. The loan agreement requires the attainment of certain working capital and tangible net worth levels and the maintenance of various financial ratios, among its provisions. Borrowings under this agreement are collateralized by the common stock of the Company's principal subsidiaries. Under the most restrictive of these covenants, at December 31, 1993 approximately $2,192,000 was available for the payment of dividends in 1994.\nFuture maturities of long-term debt, for the years 1995 through 1998 are: 1995--$430,000; 1996--$405,000; 1997--$425,000; and 1998--$448,000.\nThe net book value of property, plant and equipment pledged as collateral under mortgages and industrial revenue bonds approximated $6,688,000 at December 31, 1993.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 8 -- CONVERTIBLE SUBORDINATED DEBENTURES--SUBSEQUENT EVENT\nDuring the period February 23, 1994 to March 23, 1994 holders of $49,963,000 principal amount of 10% Convertible Senior Subordinated Discount Debentures, due October 1, 2008, exchanged them for 2,751,349 shares of common stock of the Company. The remaining $37,000 of the original $50 million face amount was redeemed by the Company. The pro forma unaudited consolidated balance sheet reflects this event as of December 31, 1993, including estimated costs. If this transaction had occurred on January 1, 1993 primary and fully diluted earnings per share for 1993 would have been $.84 and $.83, respectively.\nNOTE 9 -- INCOME TAXES\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The adoption of this standard had no material effect on prior year or 1993 earnings.\nThe provision for income taxes is composed of the following:\nThe significant components of the Company's deferred tax assets and liabilities as of December 31, 1993 are summarized below:\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Prior to the change in accounting methods, the deferred tax provision was comprised as follows:\nThe actual income tax expense varies from the Federal statutory rate applied to consolidated income as follows:\nNOTE 10 -- RETIREMENT PLANS\nThe Company provides retirement benefits to certain of its salaried and hourly employees through non-contributory defined benefit pension plans. The benefits provided are primarily based upon length of service and compensation, as defined. The Company funds the plans in amounts as actuarially determined and to the extent deductible for Federal income tax purposes. Plan assets consist primarily of investments in mutual funds and unallocated general accounts of guaranteed income contracts.\nThe components of pension expense are as follows:\nAssumptions used in the computation of net pension expense are as follows:\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The plans' funded status as September 30 is as follows:\nThe Company maintains a discretionary profit sharing plan for certain of its salaried and hourly employees who vest after meeting certain minimum age and service requirements. Profit sharing plan expense is comprised as follows:\nOne of the Company's subsidiaries maintains a 401(k) plan for its salaried employees which provides for a 1/3 match of the first six percent of employee contributions. The matched portion totaled $187,000 in 1993; $187,000 in 1992 and $173,000 in 1991.\nNOTE 11 -- STOCK OPTION PLANS\nThe Company's Executive Incentive Stock Option Plan provides for the granting of options to key employees to purchase up to 2,037,500 shares of common stock. Option prices must be 100% of fair market value at date of grant except for an employee who owns in excess of 10% of the common stock outstanding, in which case the exercise price is 110% of the fair market value at date of grant. Options are exercisable in full or in part after one year from the date of grant and expire within ten years (within five years for an employee owning in excess of 10% of the outstanding common stock). Shares acquired must be held for one year.\nThe Senior Executive Stock Option Plan (\"the Senior Plan\") authorizes the granting of either incentive or non-qualified stock options only to executives of businesses acquired by the Company or to newly employed executives. The Senior Plan provides for 750,000 shares of the Company's common stock to be reserved for issuance.\nThe 1989 Employee Incentive Stock Plan (\"the 1989 Plan\") authorizes the granting of incentive and non-qualified stock options and awards of restricted stock and is to be made available to executives and key employees of the Company. As in the Senior Plan, option terms and holding and exercise periods may vary except that no option may be exercised more than ten years after date of grant. Stock awarded under the Plan will be subject to restrictions as to sale or transfer. These restriction may lapse or be waived based on performance, period of service or other factors. The 1989 Plan provides for 3,500,000 shares of the Company's common stock to be reserved for issuance.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn 1991, the Company granted 250,000 shares of restricted stock to an executive officer of the Company. The restrictions of these shares will be released at the rate of 25,000 shares per year upon the attainment of certain profit goals and the continued employment of the officer. The restrictions will be lifted in the event of a change in control of the Company. The unamortized restricted stock resulting from this stock award has been deducted from stockholders' equity and is being written off over ten years at the fair market value on the dates the restrictions are lifted.\nFor the three years ended December 31, 1993, option activity was as follows:\n- -------- (a) May be used for incentive and non qualified options and for restricted stock.\nNOTE 12 -- COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company leases certain of its manufacturing, distribution and office facilities as well as some transportation and manufacturing equipment under noncancellable leases expiring at various dates through 2017. Certain of the real estate leases contain escalation clauses and generally provide for payment of various occupancy costs.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nFuture minimum lease payments under capital and operating leases, together with the present value at December 31, 1993 of net minimum lease payments of capital leases are as follows:\nRental expense for operating leases amounted to approximately $21,224,000 in 1993, $20,146,000 in 1992, and $17,694,000 in 1991.\nHOOVER TREATED WOOD PRODUCTS, INC. (\"HOOVER\")\nHoover, a wholly-owned subsidiary of the Company, is a defendant, along with many other parties, in a number of commercial lawsuits, including a purported class action on behalf of certain Maryland homeowners, alleging property damage caused by alleged defects in certain pressure treated interior wood products it produced and sold through August, 1988. The Company is also a defendant in many of these suits. The number of lawsuits pending as of December 31, 1993, as well as the number of lawsuits filed in 1993, has declined significantly.\nMany of the suits and claims have been settled. In those suits that remain pending, direct defense costs are being paid by either insurance carriers, under reservations of rights agreements, or out of insurance proceeds. Two actions have proceeded to trial against Hoover and resulted in jury verdicts against it. In one of these actions, judgment was entered in Hoover's favor by the court after a jury verdict against it and the plaintiff's petition to appeal from the judgment entered in Hoover's favor has been denied. Hoover is appealing the other judgment and believes that it has meritorious grounds for overturning it in whole or in part. Certain carriers have brought actions challenging coverage. Hoover and the Company believe they have meritorious claims for coverage, are defending these actions, have counterclaimed and are seeking declaratory judgments confirming coverage. Many of the coverage claims have been settled and proceeds from those settlements, along with the proceeds from a settlement of claims by Hoover against certain suppliers of materials used by it in the production of treated wood, are available for the settlement of the underlying property damage actions, including the jury verdict now on appeal. Hoover believes that its remaining coverage disputes will be resolved and a substantial amount of additional coverage will be available to it.\nHoover and the Company are vigorously defending those lawsuits which cannot be resolved on a reasonable basis and believe that they have meritorious defenses to those suits including, in the case of the Company, the defense that it has been improperly joined, as it did not manufacture or market the Hoover products at issue, and is not legally liable for the damage allegedly caused by them.\nIn evaluating the effect of the lawsuits, the Company has considered a number of factors, including: the number and exposure posed by the pending lawsuits; the significant decline in the number of lawsuits filed in\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n1993; the availability of various legal defenses, including statutes of limitation, the existence of settlement protocols, an agreement indemnifying Hoover as to certain past and future claims and Hoover's experience in settling with its insurance companies and the likely availability of additional insurance. The Company estimates that the future cost of resolving those matters not presently covered by existing settlements with insurance carriers and suppliers is sixteen million dollars, which it expects will be covered by future recoveries from additional insurance carriers. Based on its evaluation, the Company believes that the ultimate resolution of the lawsuits and the insurance claims will not have a material adverse effect upon the financial position of the Company.\nEXECUTIVE COMPENSATION\nIn the event of a change in control of the Company, as defined in resolutions adopted by the Board of Directors, senior management, except for the chairman, have the right to receive payments upon termination of employment or resignation within one year. Such payments are to be 2.75 times average annual compensation, as defined, plus 2.75 times the difference between the market and exercise price of any unexercised incentive stock options. At December 31, 1993, the maximum amount payable, applicable to twenty-five individuals, would be approximately $14,783,000 attributable to compensation and $15,248,000 to the options.\nLETTERS OF CREDIT\nAt December 31, 1993 $22,580,000 of letters of credit issued by the Company's banks were outstanding, principally in connection with certain financing transactions.\nOTHER\nThe Company and its subsidiaries are subject to legal actions from time to time which have arisen in the ordinary course of its business. In the opinion of management, the resolution of these claims will not have a material adverse effect upon the financial position of the Company.\nNOTE 13 -- INDUSTRY SEGMENT\nThe Company operates predominantly in one business segment. Operations in the Home Improvement Products Business consist of the manufacture and sale of exterior vinyl siding, wood and vinyl-framed windows and patio doors, prefinished decorative plywood and solid wood paneling, furniture components and various pressure-treated wood products and the purchase and resale of a variety of other products for the home improvement and industrial markets. One customer accounted for 12.2% and 11.2% of the Company's net sales for the years ended December 31, 1993 and December 31, 1992, respectively.\nPLY GEM INDUSTRIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 14 -- QUARTERLY RESULTS (UNAUDITED)\nEarnings per share calculations for each of the quarters presented are based on the weighted average number of shares and common equivalent shares outstanding during such periods. The sum of the quarters may not necessarily be equal to the full year earnings per share amounts.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNONE\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 12, 1994.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 12, 1994.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 12, 1994.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required is incorporated by reference from the Proxy Statement prepared with respect to the Annual Meeting of Stockholders to be held on May 12, 1994.\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as part of this report:\nFinancial Statements:\nThe list of consolidated financial statements is set forth in Part II, Item 8 of this Form 10-K and such Index to Consolidated Financial Statements is incorporated herein by reference.\nFinancial Statement Schedules:\nThe financial statement schedules that are required by Part II, Item 8 of this Form 10-K, will be filed by amendment.\nExhibits:\n(b) Reports on Form 8-K\nOn December 15, 1993 the Company reported the approval of an employment agreement with Monte R. Haymon, President, Chief Operating Officer and a Director of the Company, effective January 3, 1994.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nPly Gem Industries, Inc. (Registrant)\n/s/ Jeffrey S. Silverman By: _________________________________ JEFFREY S. SILVERMAN, CHAIRMAN (MARCH 28, 1994)\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nNAME TITLE DATE\n/s/ Jeffrey S. Silverman Chairman, Chief March 28, 1994 - ------------------------------------- Executive Officer JEFFREY S. SILVERMAN (Principal Executive Officer) and Director\n/s/ Herbert P. Dooskin Executive Vice March 28, 1994 - ------------------------------------- President and HERBERT P. DOOSKIN Director\n/s/ Stanford Zeisel Secretary and March 28, 1994 - ------------------------------------- Treasurer STANFORD ZEISEL (Principal Financial Officer)\n/s/ Jerome Baum Controller March 28, 1994 - ------------------------------------- JEROME BAUM\n/s/ Albert Hersh Director March 28, 1994 - ------------------------------------- ALBERT HERSH\n/s/ Elihu H. Modlin Director March 28, 1994 - ------------------------------------- ELIHU H. MODLIN\nEXHIBIT INDEX"},"word_count":{"kind":"number","value":9229,"string":"9,229"},"character_count":{"kind":"number","value":61002,"string":"61,002"}}},{"rowIdx":282,"cells":{"filename":{"kind":"string","value":"860004_1993.txt"},"id":{"kind":"string","value":"860004_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"860004"},"text":{"kind":"string","value":"Item 1. Business\nThe Sears Credit Account Trust 1990 B (the \"Trust\") was formed pursuant to the Pooling and Servicing Agreement dated as of February 22, 1990 (the \"Pooling and Servicing Agreement\") among Sears, Roebuck and Co. (\"Sears\") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. (\"SRFG\") as Seller, and Continental Bank, National Association as trustee (the \"Trustee\"). The Trust's only business is to act as a passive conduit to permit investment in a pool of retail consumer receivables.\nItem 2.\n\n\nItem 2. Properties\nThe property of the Trust includes a portfolio of receivables (the \"Receivables\") arising in selected accounts under open-end credit plans of Sears (the \"Accounts\") and all monies received in payment of the Receivables. At the time of the Trust's formation, Sears sold and contributed to SRFG, which in turn conveyed to the Trust, all Receivables existing under the Accounts as of the end of certain of Sears regular billing cycles ending in February, 1990 and all Receivables arising under the Accounts from time to time thereafter until the termination of the Trust. Information related to the performance of the Receivables during 1993 is set forth in the ANNUAL STATEMENT filed as Exhibit 21 to this Annual Report on Form 10-K.\nItem 3.\nItem 3. Legal Proceedings\nNone\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders\nNone\nPART II\nItem 5.\nItem 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInvestor Certificates are held and delivered in book-entry form through the facilities of The Depository Trust Company (\"DTC\"), a \"clearing agency\" registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended. All outstanding definitive Investor Certificates are held by CEDE and Co., the nominee of DTC.\nItem 9.\n\n\n\n\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPART III\nItem 12.\n\n\n\n\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 15, 1994, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1994, owned 100% of the Seller Certificate, which represented beneficial ownership of a residual interest in the assets of the Trust as provided in the Pooling and Servicing Agreement.\nItem 13.\nItem 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Exhibits:\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\n(b) Reports on Form 8-K:\nCurrent reports on Form 8-K are filed on or before the Distribution Date each month (on, or the first business day after, the 15th of the month). The reports include as an exhibit, the MONTHLY INVESTOR CERTIFICATEHOLDERS' STATEMENT. Current Reports on Form 8-K were filed on October 15, 1993, November 15, 1993, and December 15, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nSears Credit Account Trust 1990 B (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: /S/ALICE M. PETERSON _____________________________________ Alice M. Peterson President and Chief Executive Officer\nDated: March 30, 1994\nEXHIBIT INDEX\nPage number in sequential Exhibit No. number system\n21. 1993 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT AUDITOR'S REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Review of servicing procedures.\n(b) Annual Servicing Letter.\nExhibit 21\nSEARS CREDIT ACCOUNT TRUST 1990 B\n8.75% CREDIT ACCOUNT PASS-THROUGH CERTIFICATES\n1993 ANNUAL STATEMENT\nPursuant to the terms of the letter issued by the Securities and Exchange Commission dated March 30, 1990 (granting relief to the Trust from certain reporting requirements of the Securities Exchange Act of 1934, as amended), aggregated information regarding the performance of Accounts and payments to Investor Certificateholders in respect of the Due Periods related to the twelve Distribution Dates which occurred in 1993 is set forth below.\n1) The total amount of the distribution to Investor Certificateholders during 1993, per $1,000 interest............................................$87.50\n2) The amount of the distribution set forth in paragraph 1 above in respect of interest on the Investor Certificates, per $1,000 interest....................$87.50\n3) The amount of the distribution set forth in paragraph 1 above in respect of principal on the Investor Certificates, per $1,000 interest....................$0.00\n4) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods....................................$232,857,461.00\n5) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods.....................................$56,875,137.31\n6) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates...............$170,434,077.86\n7) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Investor Certificates................................$21,664,238.33\n8) The aggregate amount of Collections of Principal Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate.................................$62,423,383.14\n9) The aggregate amount of Collections of Finance Charge Receivables processed during the related Due Periods which were allocated in respect of the Seller Certificate.................................$35,210,898.98\n10) The excess of the Investor Charged-Off Amount over the sum of (i) payments in respect of the Available Subordinated Amount and (ii) Excess Servicing, if any (an \"Investor Loss\"), per $1,000 interest............$0.00\n11) The aggregate amount of Investor Losses in the Trust as of the end of the day on December 15, 1993, per $1,000 interest......................................$0.00\n12) The total reimbursed to the Trust from the sum of the Available subordinated Amount and Excess Servicing, if any, in respect of Investor Losses, per $1,000 interest.............................................$0.00\n13) The amount of the Investor Monthly Servicing Fee payable by the Trust to the Servicer.........$2,314,814.82\n14) The aggregate amount which was deposited in the Principal Funding Account in respect of Collections of Principal Receivables during the related Due Periods................................$111,111,111.12\n15) The aggregate amount of Investment Income during the related Due Periods.........................$11,747,685.19\n16) The total amount on deposit in the Principal Funding Account in respect of Collections of Principal Receivables, as of the end of the reportable year.......................................$194,444,444.46\n17) The Deficit Accumulation Amount, as of the end of the reportable year......................................$0.00\nExhibit 28(a)\nFebruary 11, 1994\nMs. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank, National Sears Tower Association as Trustee Chicago, Illinois 60684 231 South La Salle Street Chicago, Illinois 60697\nWe have applied the procedures listed below to the accounting records of Sears, Roebuck and Co. (\"Sears\") relating to the servicing procedures performed by Sears as Servicer under Section 3.06(b) of the Pooling and Servicing Agreement (the \"Agreement\") for the following Trusts:\nDate of Pooling and Trust Servicing Agreement\nSears Credit Account Trust 1989E November 13, 1989 Sears Credit Account Trust 1990A January 12, 1990 Sears Credit Account Trust 1990B February 22, 1990 Sears Credit Account Trust 1990C July 31, 1990 Sears Credit Account Trust 1990D October 15, 1990 Sears Credit Account Trust 1990E December 1, 1990\nIt is understood that this report is solely for your information and is not to be referred to or distributed for any purpose to anyone other than Continental Bank, National Association as Trustee, Investor Certificateholders or the management of Sears. The procedures we performed are as follows:\nCompared the mathematical calculations of each amount set forth in each monthly certificate forwarded by the Servicer, pursuant to Section 3.04(b) of the Agreement, during the calendar year 1993 to the Servicer's computer-generated Portfolio Monitoring and Monthly Cash Flow Allocations Report. We found such amounts to be in agreement.\nFebruary 11, 1994 Ms. Alice M. Peterson Ms. Cynthia K. Duncan Vice President and Treasurer Trust Officer Sears, Roebuck and Co. as Servicer Continental Bank, National Association as Trustee\nBecause the above procedures do not constitute an audit conducted in accordance with generally accepted auditing standards, we do not express an opinion on any of the items referred to above.\nAs a result of the procedures performed, no matters came to our attention that caused us to believe that the amounts in the monthly certificates require adjustment. Had we performed additional procedures or had we conducted an audit of the monthly certificates in accordance with generally accepted auditing standards, matters might have come to our attention that would have been reported to you. This report relates only to the items specified above and does not extend to any financial statements of Sears taken as a whole."},"word_count":{"kind":"number","value":1445,"string":"1,445"},"character_count":{"kind":"number","value":9914,"string":"9,914"}}},{"rowIdx":283,"cells":{"filename":{"kind":"string","value":"275177_1993.txt"},"id":{"kind":"string","value":"275177_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"275177"},"text":{"kind":"string","value":"Item 1. Business - -------- Carolina Telephone and Telegraph Company (the Company), a wholly-owned subsidiary of Sprint Corporation (Sprint), was incorporated under the laws of the State of North Carolina in 1968, and in 1969 acquired all of the public utility assets of the predecessor company of the same name pursuant to a plan of merger. The Company's principal offices are located at 14111 Capital Boulevard, Wake Forest, North Carolina 27587-5900 and its telephone number is (919) 554-7900. The term Company herein refers to the present Company and, as the context requires, its predecessor of the same name which was incorporated in the State of North Carolina in 1900.\nThe Company is engaged in the business of furnishing communication services, mainly local and long-distance services and network access, in 145 exchange areas serving all or part of 50 counties in the eastern part of North Carolina. As of December 31, 1993, the Company had an investment in property, plant and equipment of $1,595,266,000. Operating revenues for the year 1993 amounted to $638,541,000. No other company furnishes local telephone service in any exchange area served by the Company.\nThe principal industries in the Company's service area are agriculture, textiles, pulp and paper manufacturing, chemicals, fertilizer, and tourism. Military installations, including Fort Bragg, Camp Lejeune, Cherry Point Marine Corps Air Station, the U. S. Coast Guard Base at Elizabeth City and Pope Air Force Base contribute significantly to the economy of the area.\nDigital switching equipment and fiber optics cable represent a substantial portion of the Company's expansion of long-distance facilities. At December 31, 1993, the Company served 905,534 access lines, distributed among 145 exchange areas as follows: Fayetteville, 14.7 percent; Greenville, 5.5 percent; Rocky Mount, 4.6 percent; Jacksonville, 4.2 percent; Wilson, 3.1 percent; and all other areas less than 3.0 percent each.\nIn addition to furnishing local service, the Company's central offices and toll lines are connected with other telephone companies and with the nationwide toll networks of interexchange carriers. Toll calls may thus be made from any telephone in the Company's service area to anywhere in the United States and most other countries. Other telecommunications services, for the most part furnished in conjunction with other telephone companies, include facilities for private line service, data transmission, radio and television program transmission, mobile radio telephone, cellular and wide area telecommunications service.\nRevenues from communication services, principally telephone service, constitute about 85.9 percent of the total 1993 operating revenues of the Company. The Company has one wholly-owned subsidiary, Carolina Telephone Long Distance, Inc. (CTLD) which offers zero-plus and one-plus interlata long-distance service. A significant portion of the Company's network access revenues are derived from access charge billings to American Telephone & Telegraph Company (AT&T). Other revenues are derived in large part from the sale of telephone directory listings, the sale of telecommunications equipment, the lease of network facilities, providing operator services and processing customer toll billings for interexchange carriers, primarily AT&T.\nCarolina Telephone & Telegraph Company Form 10-K Part I\nItem 1. Business (continued) - -------- The following tables show certain information regarding access lines in service and toll messages handled at the dates or for the periods indicated.\nAccess Lines --------------------------------------------------------------- Change Number at End of Period During Period ---------------------------- ------------------- Period Residence Business Total Number % Change ------ --------- -------- ------- ------ -------- 1993 710,977 194,557 905,534 42,693 4.9 1992 681,167 181,674 862,841 36,343 4.4 1991 655,375 171,123 826,498 36,532 4.6 1990 627,778 162,188 789,966 18,514 2.4 1989 616,808 154,644 771,452 24,516 3.3\nToll Messages --------------------------------------------------------------- Total For Year Average Messages Per Day ---------------------- ------------------------ Period Number % Change Number % Change ------ ----------- -------- --------- -------- 1993 455,139,205 7.3 1,246,957 7.6 1992 424,096,621 8.8 1,158,734 8.5 1991 389,952,486 16.5 1,068,363 16.5 1990 334,783,858 7.4 917,216 7.4 1989 311,673,465 12.4 853,900 12.7\nOn December 31, 1993, the Company had 4,308 employees, of which 2,117 or 49.1 percent were represented by the Communications Workers of America, and 107 or 2.5 percent were represented by the International Brotherhood of Electrical Workers for collective bargaining purposes.\nCompliance with federal, state and local provisions relating to the protection of the environment has had no significant effect upon capital expenditures or earnings of the Company, and future effects are not expected to be material.\nEffective January 1, 1991, the Federal Communications Commission (FCC) adopted a price caps regulatory format for the Regional Bell Operating Companies and the GTE local exchange companies. Other local exchange companies (LECs) could volunteer to become subject to the price caps regulation. Under price caps, prices for access service must be adjusted annually to reflect industry average productivity gains (as specified by the FCC), inflation and certain allowed cost changes. The Company elected to be subject to price caps regulation, and under the form of the plan adopted, the Company has an opportunity to earn up to a 14.25 percent rate of return on investment.\nCarolina Telephone & Telegraph Company Form 10-K Part I\nItem 1. Business (continued) - ------- Areas of competition have emerged in the intralata and local market- place. On January 1, 1986, the intralata toll market in North Carolina was opened to non-facilities based carriers (resellers), and on January 1, 1987, facilities-based carriers were authorized to resell intralata toll. In February 1994, the North Carolina Utilities Commission approved an order authorizing long-distance companies to provide intralata toll service on a limited basis. This order, which is effective July 1, 1994, will offer customers choices in deciding which long-distance companies they want to use by dialing 1-0 and a designated 3 digit prefix code indicating the carrier of their choice.\nIn addition, the potential for more direct competition is increasing in the local service market. In May 1988, the Commission issued an order which allows customers to participate in the sharing and resale of local exchange services under shared tenant arrangements.\nAt the interstate level, the FCC has revised its rules to permit connection of customer-owned coin telephones to the local network, exposing LECs to direct coin telephone competition. Additionally, the FCC has assisted Competitive Access Providers (CAPs) in providing access to interexchange carriers and end users by mandating that all Tier I (over $100 million annual operating revenues) LECs allow collocation of CAP equipment in LEC central offices. The FCC's decision regarding collocation is under appeal to the U.S. Court of Appeals for the D.C. Circuit.\nIn October 1992, the FCC adopted a new rate structure and new pricing rules for LEC-provided switched transport. LECs filed new access transport tariffs with the FCC in September 1993, which contain rates that will purportedly reduce the costs of the largest interexchange carrier by less than 1 percent and increase the costs of the smallest carriers by less than 2 percent. The new rates, which went into effect on December 30, 1993, are not expected to have any significant impact to the LECs.\nThe extent and ultimate impact of competition for local exchange carriers will continue to depend, to a considerable degree, on FCC and Commission actions, court decisions and possible federal or state legislation. Legislation designed to stimulate local competition between local exchange service providers and cable programming service providers, in both markets, is presently pending in both houses of the U.S. Congress.\nCarolina Telephone & Telegraph Company Form 10-K Part I\nItem 2.\n\n\nItem 2. Properties - ------- The properties of the Company consist principally of land, structures, facilities and equipment. Substantially all of the Company's property, plant and equipment is restricted for use under the terms of long-term debt indentures. Central office equipment represents approximately 38.1 percent of the Company's investment in telephone plant in service; land and buildings (occupied principally by central office equipment) represent 8.2 percent; telephone instruments and related wiring and equipment including private branch exchanges (PBX) (substantially all of which are located on the premises of subscribers) represent 2.9 percent; connecting lines not on subscribers' premises (the majority of which are on or under public highways and streets and the remainder on or under private property) represent 45.9 percent; and other telephone plant represents 4.9 percent. In 141 exchanges serving approximately 84.4 percent of the Company's access lines, central offices are located on land owned by the Company; in 3 exchanges serving 0.9 percent of the Company's access lines, central offices are located in leased quarters. In one exchange (Fayetteville), central offices serving an aggregate of 14.7 percent of the Company's access lines are located in quarters, some of which are owned and some of which are leased.\nStandard practices prevailing in the telephone industry are followed by the Company in the construction and maintenance of its plant and facilities; and the Company considers that its plant and facilities are, as a whole, in sound physical and operating condition.\nThe following table shows gross additions to and retirements of properties of the Company during the five years ended December 31, 1993 (in thousands): Gross Additions Retirements --------- ----------- 1993 $146,543 $51,020 1992 143,057 89,179 1991 130,332 49,766 1990 122,760 68,754 1989 118,824 67,136\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 3.\nItem 3. Legal Proceedings - ------- No material legal proceedings are pending to which the Company or its subsidiary is a party or of which any of their property is the subject.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders - ------- No matter was submitted to a vote of security holders during the fourth quarter of 1993.\nItem 5.\nItem 5. Market for the Registrant's Common Stock and Related Stockholder - ------- Matters\nThe Registrant is a wholly-owned subsidiary of Sprint and consequently its common stock is not traded.\nItem 6.\nItem 6. Selected Financial Data (in thousands) - ------- December 31, ---------------------------------------------------- 1993 1992 1991 1990 1989 ---------- ---------- -------- -------- --------\nOperating revenues $ 638,541 $ 590,440 $552,986 $509,724 $496,841\nNet income 47,168 72,800 77,420 76,649 70,659\nTotal assets 1,078,910 1,025,295 968,806 920,489 892,575\nLong-term debt (excluding current maturities) and redeemable preferred stock 269,087 240,535 224,398 226,881 229,759\nDuring 1993, nonrecurring charges of $46,382,000 were recorded representing the portion of the costs attributable to the Company associated with the merger of Sprint and Centel Corporation. Such charges reduced 1993 net income by $27,765,000. In addition, extraordinary losses on early extinguishments of debt were recorded in 1993, which reduced net income by $2,318,000.\nEarnings and dividends per share information have been omitted because the Company is a wholly-owned subsidiary of Sprint.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 7.\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- Results of Operations\nRecent Development - ------------------\nEffective March 9, 1993, Sprint consummated its merger with Centel Corporation, a telecommunications company with local exchange and cellular/wireless communications services operations (see Note 2 of \"Notes to Consolidated Financial Statements\" for additional information). The transaction costs associated with the merger (consisting primarily of investment banking and legal fees) and the estimated expenses of integrating and restructuring the operations of the two companies (consisting primarily of employee severance and relocation expenses and costs of eliminating duplicative facilities) resulted in a nonrecurring charge to Sprint during 1993. The portion of such charge attributable to the Company was $46,382,000, which reduced 1993 net income by $27,765,000.\nLiquidity and Capital Resources - -------------------------------\nCash flows from operating activities are the Company's primary source of liquidity. Net cash provided by operating activities increased by $30,230,000 during the year ended December 31, 1993. The increase was primarily attributable to reduced payments of amounts associated with accounts payable as well as improved operating results excluding the effects of the merger and integration costs and non-cash expenses. These increases in cash flows were partially offset by payments made related to the integration of Sprint and Centel.\nIn order to meet customer demands, the Company must continually replace and construct new facilities. The Company's planned construction expenditures for 1994 are $143,131,000 which includes expenditures of $74,307,000 for central office equipment, $46,477,000 for cable facilities, $11,765,000 for general support assets and $10,582,000 for other expenditures. The Company anticipates that the funds for these expenditures will be supplied primarily by operating activities.\nThe primary source of financing for the Company has been long-term debt. In addition, the Company periodically receives cash advances from Sprint and issues commercial paper and notes payable to banks.\nNet cash used by financing activities increased $30,841,000 during the year ended December 31, 1993, compared to the same period in 1992. During 1993, the Company issued $150,000,000 in long-term debt. The proceeds of this debt were primarily used to reduce short-term debt and to retire existing higher cost long-term debt prior to scheduled maturities. The prepayment penalties incurred in connection with these early extinguishments of debt and the write-off of related debt issuance costs and unamortized premiums and discounts were $3,836,000, which reduced net income by $2,318,000. The increase in cash used related to debt activity was partially offset by reduced dividend payments during 1993.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- Results of Operations (continued)\nLiquidity and Capital Resources (continued) - -------------------------------------------\nAs of December 31, 1993, the Company had a total of $60,000,000 in one-year bank commitments. The bank lines provide for short-term borrowings at market rates of interest and require annual commitment fees based on the unused portion. Such lines of credit, which support commercial paper, may be withdrawn by the banks if there is a material adverse change in the financial condition of Sprint or the Company. As of December 31, 1993, no amounts were borrowed against this credit facility; however, $41,100,000 of the bank line supports the commercial paper outstanding at year end.\nThe Company is also authorized to issue and sell an additional $75,000,000 in debentures. The debentures must be due within thirty years of the date of issue and cannot exceed an interest rate of 7.25 percent. The new debentures, which may be issued and sold in future offerings, are available to refinance existing debt at lower interest rates, if appropriate.\nThe Company's ratio of common equity to total capital was 59.2 percent in 1993, 59.1 percent in 1992, and 61.1 percent in 1991. The Company's ratio of long-term debt to total capital was 35.4 percent in 1993, 33.2 percent in 1992, and 33.2 percent in 1991. The Company's ratio of short-term debt to total capital was 5.4 percent in 1993, 7.7 percent in 1992, and 5.7 percent in 1991.\nOperating Results - -----------------\nOperating revenues are classified as local service, network access, long-distance network and miscellaneous. Local service revenues come from providing local telephone exchange services and leasing equipment. Network access revenues are derived from billing other carriers and telephone customers for their use of the local network to complete long- distance calls in those instances where the long-distance service is not provided by the Company. Long-distance revenues are derived principally from providing long-distance services within designated areas. Miscellaneous revenues primarily relate to directory advertising, billing and collection services for interexchange long-distance carriers, operator services, network facilities leases and sales of telecommunications equipment.\nOperating revenues increased by $48,101,000 or 8.1 percent during the year ended December 31, 1993 as compared to 1992. All categories of operating revenues increased during the year.\nLocal service revenues increased $20,502,000 or 8.7 percent during 1993 as compared to 1992. Basic area service revenues contributed $10,713,000 to this increase, primarily attributable to a 4.9 percent growth in access lines during 1993. Basic area service revenues have also been impacted by the implementation of regional calling plans which have resulted in a transfer of long distance revenues to the local revenue category. Custom calling and touch tone features also added to the local service revenues as a result of access line gains and increased marketing promotions.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- Results of Operations (continued)\nOperating Results (continued) - -----------------------------\nNetwork access revenues increased $19,460,000 or 11.4 percent during the year ended December 31, 1993 as compared to 1992 due primarily to an 8.0 percent growth in access minutes of use during 1993.\nMiscellaneous revenues increased $6,518,000 or 7.8 percent during the year ended December 31, 1993 as compared to 1992. Additional telephone equipment sales and installation revenue of $6,358,000 is largely responsible for the increase during 1993. The equipment sales revenues related principally to PBX, data and key systems. North Carolina Utility Services (NCUS), a non-regulated business venture specializing in locating underground utility lines, contributed $4,703,000, due to the expansion of the service area and an increase of the customer base in existing service areas. These increases were partially offset by decreased revenues related to billing and collection services provided to interexchange carriers as well as lowered revenues associated with the lease and provision of transmission facilities to interexchange carriers.\nCustomer operations expenses increased $13,379,000 or 18.0 percent during 1993 as compared to 1992. Sales expense increased significantly during 1993, as the Company continues to intensify its efforts to achieve an increased market share and gain knowledge of its customer expectations. The results of these efforts are demonstrated in the current year increase in telephone equipment sales. As a result of continued expansions of its customer base, NCUS experienced increases in cost of goods and services during 1993. Billing services also contributed to the increase in customer operations expense, primarily due to expenses incurred during the first part of 1993 related to the development and implementation of new billing systems. Business office operations also experienced increased expenses during 1993, principally due to increased staffing requirements and expenses related to the administration and service center charges for 800 portability services.\nAs previously discussed, nonrecurring merger and integration costs totaling $46,382,000 were recognized during 1993.\nOther operating expenses increased $2,836,000 or 17.3 percent during 1993 as compared to 1992. This fluctuation was primarily due to a $4,636,000 increase in cost of equipment sales, generally corresponding with the overall trend in equipment sales. This increase was partially offset by a reduction in the losses associated with nonregulated activities during 1993.\nIn addition to the increases discussed above, plant expense, customer operations expense, corporate operations expense and other operating expense also increased as a result of higher postretirement benefits costs due to the adoption of Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" The incremental cost associated with this change in accounting principle was approximately $15,159,000.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 7. Management's Discussion and Analysis of Financial Condition and - ------- Results of Operations (continued)\nEffects of Inflation - --------------------\nThe effects of inflation on the operations of the Company were not significant during 1993, 1992 or 1991.\nRecent Accounting Developments - ------------------------------\nEffective January 1, 1994, the Company will adopt Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (see Note 1 of \"Notes to Consolidated Financial Statements\" for additional information).\nConsistent with most local exchange carriers, the Company accounts for the economic effects of regulation pursuant to SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" The application of SFAS No. 71 requires the accounting recognition of the rate actions of regulators where appropriate, including the recognition of depreciation based on estimated useful lives prescribed by regulatory commissions rather than those which might be utilized by non-regulated enterprises. The Company's management believes that the Company's operations meet the criteria for the continued application of the provisions of SFAS No. 71. With increasing competition and the changing nature of regulation in the telecommunications industry, the ongoing applicability of SFAS No. 71 must, however, be constantly monitored and evaluated. Should the Company no longer qualify for the application of the provisions of SFAS No. 71 at some future date, the accounting impact could result in the recognition of a material, extraordinary, non-cash charge.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data - -------\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nPage Reference --------------\nReport of Independent Auditors Page 11\nConsolidated Balance Sheets as of December 31, 1993 and 1992 Pages 12 - 13\nConsolidated Statements of Income for each of the three years ended December 31, 1993 Page 14\nConsolidated Statements of Retained Earnings for each of the three years ended December 31, 1993 Page 15\nConsolidated Statements of Cash Flows for each of the three years ended December 31, 1993 Pages 16 - 17\nNotes to Consolidated Financial Statements Pages 18 - 30\nCarolina Telephone & Telegraph Company Form 10-K Part II\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors Carolina Telephone and Telegraph Company\nWe have audited the accompanying consolidated balance sheets of Carolina Telephone and Telegraph Company, a wholly-owned subsidiary of Sprint Corporation, as of December 31, 1993 and 1992, and the related consolidated statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and related schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Carolina Telephone and Telegraph Company at December 31, 1993 and 1992, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, Carolina Telephone and Telegraph Company changed its method of accounting for postretirement benefits in 1993.\nERNST & YOUNG\nKansas City, Missouri January 21, 1994\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED BALANCE SHEETS December 31, 1993 and 1992 (In Thousands)\n1993 1992 ---------- ---------- ASSETS - ------\nCURRENT ASSETS Cash $ 1 $ 1 Receivables Customers and other, net of allowance for doubtful accounts of $1,895 ($1,415 in 1992) 63,090 60,957 Interexchange carriers 20,238 17,713 Affiliated companies 4,699 2,256 Inventories 9,807 7,861 Prepayments and other 870 1,573 ---------- ---------- 98,705 90,361\nPROPERTY, PLANT AND EQUIPMENT Land and buildings 128,635 120,560 Telephone network equipment and outside plant 1,370,948 1,296,144 Other 78,455 71,366 Construction in progress 17,228 11,673 ---------- ---------- 1,595,266 1,499,743 Less accumulated depreciation 673,839 610,603 ---------- ---------- 921,427 889,140\nDEFERRED CHARGES AND OTHER ASSETS 58,778 45,794 ---------- ----------\n$1,078,910 $1,025,295 ========== ==========\n(Continued)\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED BALANCE SHEETS (CONTINUED) December 31, 1993 and 1992 (In Thousands)\n1993 1992 ---------- ---------- LIABILITIES AND STOCKHOLDER'S EQUITY - ------------------------------------\nCURRENT LIABILITIES Outstanding checks in excess of cash balances $ 9,303 $ 8,169 Short-term borrowings Commercial paper 41,100 55,500 Advances from parent company - 1,703 Current maturities of long-term debt 568 7,717 Accounts payable: Vendors and other 20,742 14,846 Interexchange carriers 22,950 22,270 Affiliated companies 10,866 5,272 Accrued merger and integration costs 17,035 - Accrued taxes 13,298 13,897 Advance billings 11,653 11,262 Accrued vacation pay 10,550 10,493 Other 20,484 19,056 ---------- ---------- 178,549 170,185\nLONG-TERM DEBT 269,087 240,535\nDEFERRED CREDITS AND OTHER LIABILITIES Deferred income taxes 113,399 118,540 Deferred investment tax credits 6,790 10,830 Regulatory liability 26,338 32,903 Postretirement benefits obligation 22,542 3,750 Other 11,919 6,847 ---------- ---------- 180,988 172,870\nCOMMITMENTS\nCOMMON STOCK AND OTHER STOCKHOLDER'S EQUITY Common stock, authorized 5,000,000 shares, par value $20 per share, issued and outstanding 3,626,510 shares 72,530 72,530 Capital in excess of par value 71,991 71,991 Retained earnings 305,765 297,184 ---------- ---------- 450,286 441,705 ---------- ----------\n$1,078,910 $1,025,295 ========== ==========\nSee Notes to Consolidated Financial Statements.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 1993, 1992, and 1991 (In Thousands)\n1993 1992 1991 -------- -------- -------- OPERATING REVENUES Local service $257,050 $236,548 $219,194 Network access 189,747 170,287 165,725 Long-distance network 101,581 99,960 97,474 Miscellaneous 90,163 83,645 70,593 -------- -------- -------- 638,541 590,440 552,986\nOPERATING EXPENSES Plant expense 192,297 181,658 169,209 Depreciation 114,765 109,865 94,288 Customer operations 87,668 74,289 63,374 Corporate operations 64,400 58,300 59,932 Merger and integration costs 46,382 - - Other operating expenses 19,247 16,411 12,951 Taxes: Federal income: Current 33,786 34,218 37,826 Deferred (9,064) 1,797 1,154 Deferred investment tax credit (4,040) (4,925) (5,369) State, local and miscellaneous 22,352 25,094 25,629 -------- -------- -------- 567,793 496,707 458,994 -------- -------- --------\nOPERATING INCOME 70,748 93,733 93,992\nINTEREST CHARGES Interest on long-term debt 19,232 18,735 18,783 Other interest 2,728 3,432 1,259 -------- -------- -------- 21,960 22,167 20,042\nOTHER INCOME Interest charged to construction 54 632 87 Other, net 644 602 3,383 -------- -------- -------- 698 1,234 3,470 -------- -------- -------- INCOME BEFORE EXTRAORDINARY ITEM 49,486 72,800 77,420\nEXTRAORDINARY LOSSES ON EARLY EXTINGUISHMENTS OF DEBT, NET 2,318 - - -------- -------- --------\nNET INCOME $ 47,168 $ 72,800 $ 77,420 ======== ======== ========\nSee Notes to Consolidated Financial Statements.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years ended December 31, 1993, 1992, and 1991 (In Thousands)\n1993 1992 1991 -------- -------- --------\nBALANCE AT BEGINNING OF YEAR $297,184 $272,262 $249,445\nNet Income 47,168 72,800 77,420\nCash dividends Common stock (38,587) (47,869) (54,578) Preferred stock - (9) (25) -------- -------- --------\nBALANCE AT END OF YEAR $305,765 $297,184 $272,262 ======== ======== ========\nSee Notes to Consolidated Financial Statements.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 1993, 1992, and 1991 (In Thousands)\n1993 1992 1991 -------- -------- ------- OPERATING ACTIVITIES\nNet Income $ 47,168 $ 72,800 $ 77,420 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 114,765 109,865 94,288 Deferred income taxes and investment tax credits (14,695) (2,030) (3,240) Extraordinary losses on early extinguishments of debt 3,836 - - Changes in operating assets and liabilities: Receivables, net (7,101) (3,714) (5,489) Inventories (1,946) 264 1,682 Other current assets 703 19 (487) Accounts payable 12,170 (10,371) (2,154) Other current liabilities 19,231 (2,153) 12,735 Noncurrent assets and liabilities, net 23,597 1,000 2,750 Other, net (7,540) (5,722) (4,409) ------- ------- -------\nNET CASH PROVIDED BY OPERATING ACTIVITIES 190,188 159,958 173,096\nINVESTING ACTIVITIES\nAdditions to property, plant and equipment (146,543) (143,057) (130,332) Net cost to retire plant and equipment (509) (599) (478) Additions to investments (4,865) (8,872) (2,979) -------- -------- --------\nNET CASH USED BY INVESTING ACTIVITIES (151,917) (152,528) (133,789)\n(Continued)\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years ended December 31, 1993, 1992, and 1991 (In Thousands)\n1993 1992 1991 ------- ------- -------\nFINANCING ACTIVITIES\nProceeds from long-term borrowings $148,638 $ 49,382 $ - Retirements of long-term debt (127,521) (27,537) (2,954) Increase (decrease) in commercial paper (14,400) 25,500 9,900 Increase (decrease) in advances from parent company (1,703) (6,797) 8,500 Redemption of preferred stock - (100) (150) Dividends paid (38,587) (47,878) (54,603) Other (4,698) - - -------- -------- -------\nNET CASH USED BY FINANCING ACTIVITIES (38,271) (7,430) (39,307)\nCHANGE IN CASH - - -\nCASH AT BEGINNING OF YEAR 1 1 1 -------- -------- --------\nCASH AT END OF YEAR $ 1 $ 1 $ 1 ======== ======== ========\nSee Notes to Consolidated Financial Statements.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. ACCOUNTING POLICIES\nCarolina Telephone and Telegraph Company is engaged in the business of providing communications services, principally local, network access and long distance services in North Carolina. The principal industries in its service area include agriculture, textiles, pulp and paper manufacturing, chemicals, and tourism.\nBasis of Presentation - ---------------------\nThe accompanying consolidated financial statements include the accounts of Carolina Telephone & Telegraph Company and its wholly-owned subsidiary, Carolina Telephone Long Distance, Inc. (CTLD), collectively referred to as the \"Company\". All significant intercompany transactions have been eliminated. The Company is a wholly-owned subsidiary of Sprint Corporation (Sprint); accordingly, earnings per share information has been omitted.\nThe Company accounts for the economic effects of regulation pursuant to Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation\", which requires the accounting recognition of the rate actions of regulators where appropriate. Such actions can provide reasonable assurance of the existence of an asset, reduce or eliminate the value of an asset, or impose a liability on a regulated enterprise.\nCertain amounts in the accompanying consolidated financial statements for 1992 and 1991 have been reclassified to conform to the presentation of amounts in the 1993 consolidated financial statements. These reclassifications had no effect on net income in either year.\nInventories - -----------\nInventories consist of materials and supplies, stated at average cost, and equipment held for resale, stated at the lower of average cost or market. The sales inventory balances were $2,604,000 and $2,156,000 at December 31, 1993 and 1992, respectively.\nProperty, Plant and Equipment - -----------------------------\nProperty, plant and equipment are recorded at cost. Retirements of depreciable property are charged against accumulated depreciation with no gain or loss recognized. Repairs and maintenance costs are expensed as incurred.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. ACCOUNTING POLICIES (continued)\nDepreciation - ------------\nDepreciation expense is generally computed on a straight-line basis over estimated useful lives as prescribed by regulatory commissions. Depreciation rate changes granted by the North Carolina Utilities Commission (Commission) resulted in additional depreciation expense in 1992 of $19,365,000 which reduced net income by $11,245,000 after considering the partial offset from the related revenue settlement and income tax effects. There were no depreciation rate changes during 1993 or 1991. In addition, as ordered by the Commission, the Company recorded nonrecurring charges to depreciation expense in 1991 of $9,000,000 which reduced net income by $5,016,000. Average annual composite depreciation rates, excluding the nonrecurring charges, were 7.5 percent for 1993, 7.6 percent for 1992 and 6.2 percent for 1991.\nIncome Taxes - ------------\nOperations of the Company are included in the consolidated federal income tax returns of Sprint. Federal income tax is calculated by the Company on the basis of its filing a separate return.\nEffective January 1, 1992, the Company changed its method of accounting for income taxes by adopting SFAS No. 109, \"Accounting for Income Taxes\", which requires an asset and liability approach to accounting for income taxes. Under the provisions of SFAS No. 109, the Company adjusted existing deferred income tax amounts, using current tax rates, for the estimated future tax effects attributable to temporary differences between the tax bases of the Company's assets and liabilities and their reported amounts in the financial statements. The Company's principal temporary difference results from using different depreciable lives and methods with respect to its property, plant and equipment for tax and financial reporting purposes.\nAs a result of corporate income tax rate reductions in prior years and the previous income tax accounting standards which did not permit accumulated deferred income tax amounts to be adjusted for subsequent tax rate changes, adoption of SFAS No. 109 resulted in a decrease in the amount of deferred income tax liabilities recorded. However, because this decrease will accrue to the benefit of the Company's customers through future telephone rates established by the Company's regulators, this decrease in deferred income tax liabilities has been reflected as a regulatory liability in the Company's financial statements.\nAccordingly, the adoption of SFAS No. 109 had no significant effect upon the Company's 1992 net income. As allowed by SFAS No. 109, prior years' consolidated financial statements were not restated.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. ACCOUNTING POLICIES (continued)\nIncome Taxes (continued) - ------------------------\nDuring 1991, in accordance with Accounting Principles Board Opinion No. 11, deferred income taxes were provided for all differences in timing of reporting income and expenses for financial statement and income tax purposes, except for items that were not allowable by the Federal Communications Commission (FCC) or the Commission as an expense for rate- making purposes.\nInvestment tax credits (ITC) are deferred and amortized over the useful life of the related property. The Tax Reform Act of 1986 effectively eliminated ITC after December 31, 1985.\nPostretirement Benefits - -----------------------\nEffective January 1, 1993, the Company changed its method of accounting for postretirement benefits (principally health care benefits) provided to certain retirees by adopting SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires accrual of the expected cost of providing postretirement benefits to employees and their dependents or beneficiaries during the years employees earn the benefits. As permitted by SFAS No. 106, the Company elected to recognize the obligation for postretirement benefits already earned by its current retirees and active work force as of January 1, 1993 by amortizing such obligation on a straight-line basis over a period of twenty years.\nDuring 1992 and 1991, the Company expensed postretirement benefits as such costs were paid.\nPostemployment Benefits - -----------------------\nEffective January 1, 1994, the Company will adopt SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" Under the new standard, the Company is required to recognize certain previously unrecorded obligations for benefits provided to former or inactive employees and their dependents, after employment but before retirement. Postemployment benefits offered by the Company include severance, workers' compensation and disability benefits, including the continuation of other benefits such as health care and life insurance coverage. As required by the standard, the Company will recognize its obligations for postemployment benefits through a cumulative adjustment in the consolidated income statement. The resulting nonrecurring, non-cash charge will not significantly impact the Company's 1994 net income. Adoption of this standard is not expected to significantly impact future operating expenses.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n1. ACCOUNTING POLICIES (continued)\nInterest Charged to Construction - --------------------------------\nIn accordance with the Uniform System of Accounts, as prescribed by the FCC, interest is capitalized only on those telephone plant construction projects for which the estimated construction period exceeds one year.\n2. MERGER AND INTEGRATION COSTS\nEffective March 9, 1993, Sprint consummated its merger with Centel Corporation (Centel), a telecommunications company with local exchange and cellular/wireless communications services operations. Centel's local exchange telephone businesses operate in six states: Florida, North Carolina, Virginia, Illinois, Texas and Nevada. Pursuant to the Agreement and Plan of Merger dated May 27, 1992, Sprint issued 1.37 shares of its common stock in exchange for each outstanding share of Centel common stock.\nThe operations of the merged companies are being integrated and restructured to achieve efficiencies which are expected to yield significant operational synergies and cost savings. The transaction costs associated with the merger and the estimated expenses of integrating and restructuring the operations of the two companies resulted in nonrecurring charges to Sprint during 1993. The portion of such charges attributable to the Company was $46,382,000, which reduced 1993 net income by approximately $27,765,000.\n3. EMPLOYEE BENEFIT PLANS\nDefined Benefit Pension Plan - ----------------------------\nSubstantially all employees of the Company are covered by a noncontributory defined benefit pension plan. For participants of the plan represented by collective bargaining units, benefits are based upon schedules of defined amounts as negotiated by the respective parties. For participants not covered by collective bargaining agreements, the plan provides pension benefits based upon years of service and participants' compensation.\nThe Company's policy is to make contributions to the plan each year equal to an actuarially determined amount consistent with applicable federal tax regulations. The funding objective is to accumulate funds at a relatively stable rate over the participants' working lives so that benefits are fully funded at retirement. As of December 31, 1993, the plan's assets consisted principally of investments in corporate equity securities and U.S. government and corporate debt securities.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n3. EMPLOYEE BENEFIT PLANS (continued)\nDefined Benefit Pension Plan (continued) - ----------------------------------------\nThe components of the net pension credits and related assumptions are as follows (in thousands): 1993 1992 1991 -------- -------- -------- Service cost -- benefits earned during the period $ 5,505 $ 4,739 $ 4,622 Interest cost on projected benefit obligation 15,654 14,745 14,047 Actual return on plan assets (41,636) (15,461) (65,761) Net amortization and deferral 11,403 (9,789) 42,132 -------- -------- --------\nNet pension credit $ (9,074) $ (5,766) $ (4,960) ======== ======== ========\nDiscount rate 8.00% 8.50% 8.50% Expected long-term rate of return on plan assets 9.50% 8.25% 8.25% Anticipated composite rate of future increases in compensation 5.50% 6.33% 7.02%\nIn addition, the Company recognized pension curtailment gains of $98,000 during 1993 as a result of the integration actions as discussed in Note 2.\nThe funded status and amounts recognized in the consolidated balance sheets for the plan, as of December 31, are as follows (in thousands):\n1993 1992 --------- --------- Actuarial present value of pension benefit obligations Vested benefit obligation $(207,186) $(166,022) ========= =========\nAccumulated benefit obligation $(231,695) $(182,369) ========= =========\nProjected benefit obligation $(241,000) $(198,533) Plan assets at fair value 344,187 311,202 --------- --------- Plan assets in excess of the projected benefit obligation 103,187 112,669 Unrecognized net gains (35,769) (40,377) Unrecognized prior service cost (benefit) 5,464 (4,112) Unamortized portion of transition asset (40,236) (44,706) --------- ---------\nPrepaid pension cost $ 32,646 $ 23,474 ========= =========\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n3. EMPLOYEE BENEFIT PLANS (continued)\nDefined Benefit Pension Plan (continued) - ----------------------------------------\nThe projected benefit obligations as of December 31, 1993 and 1992 were determined using a discount rate of 7.50 percent for 1993 and 8.00 percent for 1992, and anticipated composite rates of future increases in compensation of 4.50 percent for 1993 and 5.50 percent for 1992.\nDefined Contribution Plans - --------------------------\nSprint sponsors two defined contribution employee savings plans covering substantially all employees of the Company. Participants may contribute portions of their compensation to the plans. Contributions of participants represented by collective bargaining units are matched by the Company based upon defined amounts as negotiated by the respective parties. Contributions of participants not covered by collective bargaining agreements are also matched by the Company. For these participants, the Company provides matching contributions equal to 50 percent of participants' contributions up to 6 percent of their base compensation and may, at the discretion of Sprint's Board of Directors, provide additional matching contributions based upon the performance of Sprint's common stock price in comparison to other telecommunications companies. The Company's contributions to the plans aggregated $3,278,000, $2,195,000 and $2,300,000 in 1993, 1992 and 1991, respectively.\nPostretirement Benefits - -----------------------\nThe Company provides other postretirement benefits (principally health care benefits) to certain retirees. Substantially all employees who retired from the Company before January 1, 1991 became eligible for these postretirement benefits at reduced cost to the retirees. Employees retiring after such date, who meet specified age and years of service requirements, are eligible for these benefits on a shared cost basis, with the Company's portion of the cost determined by the retirees' years of credited service at retirement. The Company funds the accrued costs as benefits are paid.\nFor regulatory purposes, the FCC permits recognition of net postretirement benefits costs, including amortization of the transition obligation, in accordance with SFAS No. 106. The Company is also recording postretirement benefits costs in accordance with SFAS No. 106 for state regulatory purposes, pending direction from the Commission in future rate- making procedures.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n3. EMPLOYEE BENEFIT PLANS (continued)\nPostretirement Benefits (continued) - -----------------------------------\nThe components of the 1993 net postretirement benefits cost are as follows (in thousands):\nService cost-benefits earned during the period $ 2,514 Interest on accumulated postretirement benefits obligation 9,599 Amortization of transition obligation 5,912 ---------\nNet postretirement benefits cost $ 18,025 =========\nFor measurement purposes, an annual health care cost trend rate of 13 percent was assumed for 1993, gradually decreasing to 6 percent by 2001 and remaining constant thereafter. The effect of a one percent increase in the assumed trend rate would have increased the 1993 net postretirement benefits cost by approximately $328,000. The discount rate for 1993 was 8 percent.\nIn addition, the Company recognized postretirement benefits curtailment losses of $2,963,000 during 1993 as a result of the integration actions as discussed in Note 2.\nThe cost of providing health care benefits to retirees was $2,383,000 and $2,382,000 in 1992 and 1991, respectively.\nThe amount recognized in the consolidated balance sheet as of December 31, 1993 is as follows (in thousands):\nAccumulated postretirement benefits obligation Retirees $ 52,590 Active plan participants - fully eligible 32,830 Active plan participants - other 45,727 --------- 131,147\nUnrecognized net gains 3,387 Unrecognized transition obligation (111,992) ---------\nAccrued postretirement benefits cost $ 22,542 =========\nThe accumulated benefits obligation as of December 31, 1993 was determined using a discount rate of 7.5 percent. An annual health care cost trend rate of 12 percent was assumed for 1994, gradually decreasing to 6 percent by 2001 and remaining constant thereafter. The effect of a one percent annual increase in the assumed health care cost trend rate would have increased the accumulated benefits obligations as of December 31, 1993 by approximately $32,830,000.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n4. INCOME TAXES\nThe components of federal and state income tax expense are as follows (in thousands):\n1993 1992 1991 -------- -------- -------- Federal income taxes Current $ 33,786 $ 34,218 $ 37,826 Deferred (9,064) 1,797 1,154 Amortization of deferred ITC (4,040) (4,925) (5,369) -------- -------- -------- 20,682 31,090 33,611\nState income taxes Current 7,746 8,242 9,162 Deferred (1,591) 1,098 975 -------- -------- -------- 6,155 9,340 10,137 -------- -------- --------\nTotal income tax expense $ 26,837 $ 40,430 $ 43,748 ======== ======== ========\nIn 1993 income tax benefits of $1,518,000 associated with the extraordinary losses incurred related to the early extinguishments of debt were reflected as reductions of such losses in the consolidated statements of income.\nThe differences which cause the effective income tax rate to vary from the statutory federal income tax rate of 35 percent in 1993 and 34 percent in 1992 and 1991 are as follows (in thousands):\n1993 1992 1991 -------- -------- -------- Federal income tax at the statutory rate $ 26,713 $ 38,498 $ 41,197 Less amortization of deferred ITC 4,040 4,883 5,200 -------- -------- -------- Expected federal income tax provision after amortization of deferred ITC 22,673 33,615 35,997 Effect of Differences required to be flowed through by regulatory commissions 543 673 290 Reversal of rate differentials (1,096) (1,496) (1,821) State income tax, net of federal income tax effect 4,001 6,164 6,690 Other, net 716 1,474 2,592 -------- -------- --------\nIncome tax expense, including ITC $ 26,837 $ 40,430 $ 43,748 ======== ======== ========\nEffective income tax rate 35.2% 35.7% 36.1% ======== ======== ========\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n4. INCOME TAXES (continued)\nDuring 1993 and 1992, in accordance with SFAS No. 109, deferred income taxes were provided for the temporary differences between the carrying amounts of the Company's assets and liabilities for financial statement purposes and their tax bases. The sources of the differences that give rise to the deferred income tax assets and liabilities as of December 31, along with the income tax effect of each, are as follows (in thousands):\n1993 1992 --------------------- --------------------- Deferred Income Tax Deferred Income Tax --------------------- --------------------- Assets Liabilities Assets Liabilities -------- ----------- -------- ----------- Property, plant and equipment $ - $122,697 $ - $114,888 Allowance for doubtful accounts 373 - 426 - Expense accruals 2,795 - - 3,235 Deferred ITC - 6,790 - 10,830 Other, net 5,726 - 265 1,296 -------- -------- -------- -------- $ 8,894 $129,487 $ 691 $130,249 ======== ======== ======== ========\nOn August 10, 1993, the Revenue Reconciliation Act of 1993 (the Act) was enacted which, among other changes, raised the federal income tax rate for corporations to 35 percent from 34 percent, retroactive to the beginning of the year. Pursuant to SFAS No. 71, the resulting adjustments to the Company's deferred income tax assets and liabilities to reflect the revised rate have generally been reflected as reductions to the related regulatory liabilities.\nDuring 1991, in accordance with APB No. 11, deferred income tax provisions resulted from the differences in the timing of recognizing certain revenues and expenses for financial statement and income tax purposes. The sources of the differences, along with the income tax effect of each, were as follows (in thousands):\nProperty, plant and equipment $ 6,331 Pension costs 1,869 Revenue accruals 1,098 Expense accruals (6,647) Other, net (522) ------- $ 2,129 =======\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n5. LONG-TERM DEBT AND EXTRAORDINARY LOSSES ON EXTINGUISHMENTS\nLong-term debt as of December 31, excluding current maturities, is as follows (in thousands):\n1993 1992 --------------------------- -------- Weighted Average Amount Interest Rate Amount -------- ---------------- -------- Debentures, maturities 1995 - 2016 $271,878 6.81% $242,052\nOther notes, maturities 1995 - 1998 219 9.51% 345\nUnamortized debt discount (3,010) (1,862) -------- -------- $269,087 $240,535 ======== ========\nLong-term debt maturities during each of the next five years are as follows (in thousands):\nYear Amount ---- ------- 1994 $ 568 1995 8,575 1996 12,663 1997 841 1998 6\nThe first mortgage bonds and notes are secured by substantially all of the Company's property, plant and equipment.\nAs of December 31, 1993, the Company had lines of credit with banks totaling $60,000,000. No amounts were borrowed against these lines of credit at year end. The bank lines, which are renewable in April 1994, provide for short-term borrowings at market rates of interest and require annual commitment fees based on the unused portion. Lines of credit, which support both outstanding commercial paper and notes payable to banks, may be withdrawn by the banks if there is a material adverse change in the financial condition of the Company.\nDuring 1993, the Company redeemed prior to scheduled maturities $120,209,000 of first mortgage bonds and debentures with interest rates ranging from 7.75 percent to 11.75 percent. Prepayment penalties incurred in connection with the early extinguishments of debt and the write-off of related debt issuance costs and unamortized debt discounts and premiums, net of the related income tax benefits, are reflected as extraordinary losses in the 1993 consolidated statement of income.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n6. COMMITMENTS\nGross rental expense aggregated $6,959,000 in 1993, $6,145,000 in 1992 and $6,967,000 in 1991.\nThe Company's planned capital expenditures for the year ending December 31, 1994 are approximately $143,131,000. Normal purchase commitments have been or will be made for these planned expenditures.\n7. RELATED PARTY TRANSACTIONS\nThe Company purchases telecommunications equipment, construction and maintenance equipment, and materials and supplies from its affiliate, North Supply Company. Total purchases for 1993, 1992, and 1991 were $47,401,000, $45,272,000 and $36,421,000, respectively.\nUnder an agreement with Sprint, the Company reimburses Sprint for data processing services, other data related costs and certain management costs which are incurred for the Company's benefit. A credit resulting from deferred income taxes on intercompany profits is also allocated by Sprint to affiliated companies. Total charges to the Company aggregated $55,885,000, $43,481,000 and $36,590,000 in 1993, 1992 and 1991, respectively, and the credit relating to deferred income taxes was $852,500, $714,000 and $824,000 in 1993, 1992 and 1991, respectively. The Company enters into cash advance and borrowing transactions with Sprint; generally, interest on such transactions is computed based on the prior month's thirty-day average commercial paper index, as published in the Federal Reserve Statistical Release H.15, plus 45 basis points. Interest expense on such advances from Sprint was $19,800, $402,000 and $101,000 in 1993, 1992 and 1991, respectively. Interest income on such advances to Sprint was $51,000, $9,100 and $21,500 in 1993, 1992 and 1991, respectively.\nSprint Publishing & Advertising, an affiliate, pays the Company a fee for the right to publish telephone directories in the Company's operating territory, a listing fee, and a fee for billing and collection services performed for Sprint Publishing & Advertising by the Company. For 1993, 1992 and 1991, Sprint Publishing & Advertising paid the Company a total of $21,759,000, $21,526,000 and $20,109,000, respectively. The Company paid Sprint Publishing & Advertising $1,543,000, $1,515,000 and $1,174,000 in 1993, 1992 and 1991, respectively, for its costs of publishing the white page portion of the directories.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n7. RELATED PARTY TRANSACTIONS (continued)\nThe Company provides various services to Sprint's long distance communications services division, such as network access, operator and billing and collection services, and the lease of network facilities. The Company recognized income of $18,017,000, $16,698,000 and $15,694,000 in 1993, 1992 and 1991, respectively, for these services. The Company paid Sprint's long distance communications services division $25,000,000, $22,811,000 and $21,797,000 in 1993, 1992 and 1991, respectively, for interexchange telecommunications services.\nThe Company provides services such as operator assistance, directory assistance, end user trouble report processing and payment processing for United Telephone-Southeast, Inc. (an affiliate) and United Telephone Company of the Carolinas, (an affiliate). The Company recognized income of $3,324,000, $2,525,000, and $1,025,000 during 1993, 1992 and 1991, respectively, for these services.\nCertain directors and officers of the Company are also directors or officers of banks at which the Company conducts borrowings and related transactions. The terms are comparable with other banks at which the Company has similar transactions.\n8. ADDITIONAL FINANCIAL INFORMATION\nFinancial Instruments Information - ---------------------------------\nThe Company's financial instruments consist of long-term debt, including current maturities, with carrying amounts as of December 31, 1993 and 1992 of $269,655,000 and $248,252,000, respectively, and estimated fair values of $288,871,000 and $257,624,000, respectively. The fair values are estimated based on quoted market prices for publicly-traded issues, and based on the present value of estimated future cash flows using a discount rate commensurate with the risks involved for all other issues.\nThe carrying values of the Company's other financial instruments (principally short-term borrowings) approximate fair value as of December 31, 1993 and 1992.\nCarolina Telephone & Telegraph Company Form 10-K Part II\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993\n8. ADDITIONAL FINANCIAL INFORMATION (continued)\nSupplemental Cash Flows Information - -----------------------------------\nThe supplemental disclosures required for the consolidated statements of cash flows for the years ended December 31, are as follows (in thousands):\n1993 1992 1991 ------- ------- ------- Cash paid for Interest, net of amounts capitalized $20,395 $22,884 $21,564 Income taxes 41,391 44,884 42,030\nMajor Customer Information - --------------------------\nOperating revenues from American Telephone & Telegraph resulting primarily from network access, billing and collection services, and the lease of network facilities aggregated approximately $105,225,000, $101,418,000 and $97,679,000 for 1993, 1992 and 1991, respectively.\n9. SUPPLEMENTAL QUARTERLY INFORMATION - UNAUDITED (in thousands)\n1993 Quarters Ended ------------------------------------------------ March 31 June 30 September 30 December 31 -------- -------- ------------ ----------- Operating revenues $152,282 $159,756 $163,536 $162,967 Operating income (loss) (1,869) 23,895 28,038 20,684 Income (loss) before extraordinary item (7,464) 18,436 23,147 15,367 Net income (loss) (7,464) 17,070 22,195 15,367\n1992 Quarters Ended ------------------------------------------------ March 31 June 30 September 30 December 31 -------- -------- ------------ ----------- Operating revenues $137,608 $146,034 $149,770 $157,028 Operating income 25,058 28,027 25,785 14,863 Net income 19,749 22,905 20,782 9,364\nNonrecurring charges associated with the transaction costs of the Sprint/Centel merger and the estimated expenses of integrating and restructuring the operations of the two companies were recorded during 1993. The portion of such charges attributable to the Company was $41,700,000 and $4,682,000 in the first and fourth quarters of 1993, respectively, which reduced net income by approximately $25,346,000 and $2,419,000, respectively.\nThe Company recorded additional depreciation expense of approximately $19,365,000 during the fourth quarter of 1992 as the result of depreciation rate changes granted by the Commission. The effect of this adjustment on 1992 fourth quarter net income was $11,245,000.\nCarolina Telephone & Telegraph Company Form 10-K Part II/III/IV\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and - ------- Financial Disclosure\nNone\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant - --------\nOmitted under the provisions of General Instruction J.\nItem 11.\nItem 11. Executive Compensation - --------\nOmitted under the provisions of General Instruction J.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management - --------\nOmitted under the provisions of General Instruction J.\nItem 13.\nItem 13. Certain Relationships and Related Transactions - --------\nOmitted under the provisions of General Instruction J.\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - --------\n(a) 1. The consolidated financial statements of the Company filed as part of this report are listed in the Index to Consolidated Financial Statements on page 10.\n2. The consolidated financial statement schedules of the Company filed as part of this report are listed in the Index to Consolidated Financial Statement Schedules on page 32.\n(b) The Registrant was not required to file a report on Form 8-K during the last quarter of 1993.\n(c) The exhibits filed as part of this report are listed in the Index to Exhibits on pages 42 - 44.\nCarolina Telephone & Telegraph Company Form 10-K Part IV\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES (ITEM 14(a)2.)\nPage For each of the three years in the period ended December 31, 1993: Reference - ------------------------------------------------------------------ ---------\nSchedule V - Property, Plant and Equipment - Consolidated Pages 33-35 Schedule VI - Accumulated Depreciation on Property, Plant and Equipment - Consolidated Pages 36-38 Schedule VIII - Valuation and Qualifying Accounts - Consolidated Page 39 Schedule IX - Short-Term Borrowings - Consolidated Page 40 Schedule X - Supplementary Income Statement Information - Consolidated Page 41\nAll other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements, including the notes thereto.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1993\n(In Thousands)\nBalance Retirements Balance beginning Additions or end of year at cost sales of year ---------- ----------- ----------- ----------\nLand and buildings $ 120,560 $ 8,619 $ 544 $ 128,635\nOther general support assets 65,424 12,853 5,897 72,380\nCentral office assets 562,672 67,120 28,746 601,046\nInformation origination/ termination assets 44,301 7,727 5,749 46,279\nCable and wire facilities assets 689,171 44,314 9,862 723,623\nAmortizable assets 4,431 355 222 4,564\nProperty held for future use 310 - - 310\nTelephone plant under construction 11,673 5,555 - 17,228\nTelephone plant acquisition adjustment 342 - - 342\nNonoperating plant 859 - - 859 ---------- -------- -------- ----------\n$1,499,743 $146,543 $51,020 $1,595,266 ========== ======== ======== ==========\nDepreciation expense is computed on a straight-line basis. The average annual composite depreciation rate in 1993 was 7.5%.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1992\n(In Thousands)\nBalance Retirements Balance beginning Additions or end of year at cost sales of year ---------- ---------- ---------- ----------\nLand and buildings $ 92,700 $ 28,394 $ 534 $ 120,560\nOther general support assets 59,841 10,911 5,328 65,424\nCentral office assets 524,038 67,512 28,878 562,672\nInformation origination/ termination assets 84,180 5,265 45,144 44,301\nCable and wire facilities assets 655,864 42,176 8,869 689,171\nAmortizable assets 4,696 161 426 4,431\nProperty held for future use 376 (66) - 310\nTelephone plant under construction 22,969 (11,296) - 11,673\nTelephone plant acquisition adjustment 342 - - 342\nNonoperating plant 859 - - 859 ---------- -------- ------- ----------\n$1,445,865 $143,057 $89,179 $1,499,743 ========== ======== ======= ==========\nDepreciation expense is computed on a straight-line basis. The average annual composite depreciation rate in 1992 was 7.6%.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1991\n(In Thousands)\nBalance Retirements Balance beginning Additions or end of year at cost sales of year ---------- ------------ ----------- -----------\nLand and buildings $ 86,427 $ 7,078 $ 805 $ 92,700\nOther general support assets 55,839 8,831 4,829 59,841\nCentral office assets 493,218 60,232 29,412 524,038\nInformation origination/ termination assets 83,571 5,287 4,678 84,180\nCable and wire facilities assets 628,570 37,097 9,803 655,864\nAmortizable assets 4,845 90 239 4,696\nProperty held for future use 1,396 (1,020) - 376\nTelephone plant under construction 9,994 12,975 - 22,969\nTelephone plant acquisition adjustment 520 (178) - 342\nNonoperating plant 919 (60) - 859 ---------- -------- ------- ----------\n$1,365,299 $130,332 $49,766 $1,445,865 ========== ======== ======= ==========\nDepreciation expense is computed on a straight-line basis. The average annual composite depreciation rate in 1991 was 6.2%.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE VI - ACCUMULATED DEPRECIATION ON PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1993\n(In Thousands)\nBalance Charged to Retirements Balance beginning depreciation Net or end of year expense salvage sales of year --------- ---------- --------- ----------- --------\nBuildings $ 27,126 $ 4,154 $ (263) $ 517 $ 30,500\nOther general support assets 26,930 8,027 693 5,968 29,682\nCentral office assets 174,863 54,081 29 28,746 200,227\nInformation origination/ termination assets 31,000 3,701 637 5,686 29,652\nCable and wire facilities assets 348,091 44,449 (1,600) 9,803 381,137\nAmortizable assets 1,422 310 (5) 300 1,427\nProperty held for future use 25 10 - - 35\nTelephone plant acquisition adjustment 487 33 - - 520\nNonoperating plant 659 - - - 659 -------- -------- -------- ------- --------\n$610,603 $114,765 $ (509) $51,020 $673,839 ======== ======== ======== ======= ========\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE VI - ACCUMULATED DEPRECIATION ON PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1992\n(In Thousands)\nBalance Charged to Retirements Balance beginning depreciation Net or end of year expense salvage sales of year -------- ------------ -------- --------- --------\nBuildings $ 24,632 $ 3,232 $ (204) $ 534 $ 27,126\nOther general support assets 24,366 7,347 544 5,327 26,930\nCentral office assets 151,089 53,136 (483) 28,879 174,863\nInformation origination/ termination assets 72,007 3,489 648 45,144 31,000\nCable and wire facilities assets 315,768 42,363 (1,171) 8,869 348,091\nAmortizable assets 1,526 255 67 426 1,422\nProperty held for future use 15 10 - - 25\nTelephone plant acquisition adjustment 454 33 - - 487\nNonoperating plant 659 - - - 659 -------- -------- -------- ------- --------\n$590,516 $109,865 $ (599) $89,179 $610,603 ======== ======== ======== ======= ========\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE VI - ACCUMULATED DEPRECIATION ON PROPERTY, PLANT AND EQUIPMENT - CONSOLIDATED\nYear Ended December 31, 1991\n(In Thousands)\nBalance Charged to Retirements Balance beginning depreciation Net or end of year expense salvage sales of year -------- ------------ ------- ----------- -------\nBuildings $ 23,384 $ 2,107 $ (99) $ 760 $ 24,632\nOther general support assets 23,494 5,426 275 4,829 24,366\nCentral office assets 140,203 40,979 (912) 29,181 151,089\nInformation origination/ termination assets 73,119 2,663 1,180 4,955 72,007\nCable and wire facilities assets 283,716 42,820 (965) 9,803 315,768\nAmortizable assets 1,476 250 38 238 1,526\nProperty held for future use - 10 5 - 15\nTelephone plant acquisition adjustment 421 33 - - 454\nNonoperating plant 659 - - - 659 -------- ------- ------- ------- --------\n$546,472 $94,288 $ (478) $49,766 $590,516 ======== ======= ======= ======= ========\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS - CONSOLIDATED\nYears Ended December 31, 1993, 1992 and 1991\n(In Thousands)\nDeductions ----------- Additions Accounts Balance at ---------- charged off Balance beginning Charged to net of at end of year expense collections of year ---------- ---------- ----------- ------- Year ended December 31, 1993 - ---------------------------- Deducted from assets: Allowance for uncollectible accounts $1,415 $1,965 $1,485 $1,895 ====== ====== ====== ======\nYear ended December 31, 1992 - ---------------------------- Deducted from assets: Allowance for uncollectible accounts $1,319 $1,613 $1,517 $1,415 ====== ====== ====== ======\nYear ended December 31, 1991 - ---------------------------- Deducted from assets: Allowance for uncollectible accounts $1,478 $1,816 $1,975 $1,319 ====== ====== ====== ======\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE IX - SHORT-TERM BORROWINGS - CONSOLIDATED\nYears Ended December 31, 1993, 1992 and 1991\n(In Thousands)\n1993 1992 1991 Commercial Commercial Commercial Paper Paper Paper ---------- ---------- ----------\nAmount outstanding at end of year $41,100 $55,500 $30,000 ======= ======= =======\nMaximum amount outstanding at any month end $59,900 $55,500 $30,000 ======= ======= =======\nApproximate average amount outstanding during the year $46,764 $30,129 $24,930 ======= ======= =======\nApproximate weighted average interest rate for the year (computed by dividing the annual interest expense by the average debt outstanding during the year) 3.24% 4.17% 6.06% ======= ======= =======\nAverage interest rate at end of year 3.37% 4.12% 5.31% ======= ======= =======\nCommercial paper is generally carried for periods ranging from 15 days to 30 days.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION - CONSOLIDATED\nYears Ended December 31, 1993, 1992 and 1991\n(In Thousands)\nYear ended December 31, --------------------------- 1993 1992 1991 ------- ------- ------- Taxes other than payroll and income taxes:\nGross receipts taxes $ 7,009 $ 6,562 $ 6,031\nProperty taxes 8,484 8,054 8,080\nOther state and local taxes 704 1,138 1,381 ------- ------- -------\n$16,197 $15,754 $15,492 ======= ======= =======\nMaintenance expense is the primary component of plant expense which is shown separately in the Consolidated Statement of Income.\nThe Company had no significant advertising expense and paid no royalties during 1993, 1992 and 1991.\nCarolina Telephone and Telegraph Company Form 10-K Part IV\nINDEX TO EXHIBITS\nITEM 14(c)\nExhibit No. 3 Articles of incorporation and by-laws (filed as Exhibit 3 to 1980 Annual Report Form 10-K and incorporated herein by reference).\n4 Instruments defining the rights of security holders, including indentures, contained in documents previously filed with the Commission are incorporated herein by reference.\n4(A) Indenture dated as of February 1, 1963, from the Company to Bankers Trust Company, Trustee (See Current Report Form 8-K for February 1963, Exhibit 4-F).\n4(B) Indenture dated as of March 1, 1965, from the Company to Bankers Trust Company, Trustee (See Current Report Form 8-K for March 1965, Exhibit A).\n4(C) Indenture dated as of March 1, 1966, from the Company to Bankers Trust Company, Trustee (See Current Report Form 8-K for March 1966, Exhibit A).\n4(D) Indenture dated as of January 15, 1968, from the Company to North Carolina National Bank as Trustee (See Registration No. 2-27816, Exhibit 4-J).\n4(E) Indenture dated as of October 1, 1970, from the Company to Bankers Trust Company, as Trustee (See Registration NO. 2- 38292, Exhibit 4-J).\n4(F) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of July 1, 1948 (See Registration No. 2-34018, Exhibit 4-K).\n4(G) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of August 1, 1952 (See Registration No. 2-34018, Exhibit 4-L).\n4(H) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of August 1, 1957 (See Registration No. 2-34018, Exhibit 4-M).\nCarolina Telephone & Telegraph Company Form 10-K Part IV\nINDEX TO EXHIBITS (CONTINUED) ITEM 14(c)\nExhibit No. 4(I) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of February 1, 1963 (See Registration No. 2- 34018, Exhibit 4-N).\n4(J) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of March 1, 1965 (See Registration No. 2-34018, Exhibit 4-O).\n4(K) Supplemental Indenture from the Company to Bankers Trust Company dated as of March 28, 1969 supplementing Indenture dated as of March 1, 1966 (See Registration No. 2-34018, Exhibit 4-P).\n4(L) Supplemental Indenture from the Company to North Carolina National Bank dated as of March 28, 1969 supplementing Indenture dated as of January 15, 1968 (See Registration No. 2-34018, Exhibit 4-Q).\n4(M) Indenture dated as of August 1, 1969 from the Company to Bankers Trust Company (See Registration No. 2-34018, Exhibit 4-A).\n4(N) Indenture dated as of October 1, 1971 from the Company to Bankers Trust Company (See Registration No. 2-41721, Exhibit 2-A).\n4(O) Indenture dated as of November 1, 1973 from the Company to Bankers Trust Company (See Registration No. 2-49251, Exhibit 2-A).\n4(P) Indenture dated as of May 1, 1978 from the Company to Bankers Trust Company (See Registration No. 2-61151, Exhibit 2-A).\n4(Q) Indenture dated as of October 26, 1978 from the Company to Bankers Trust Company (See Administrative Proceeding File No. 3-5541, Exhibit 5).\n4(R) Indenture dated as of December 27, 1979 from the Company to Bankers Trust Company (See the Company's Application, File Nos. 2-34018, 2-38292, 2-41721, 2-49251 and 2-61151, Exhibit 5).\nCarolina Telephone & Telegraph Company Form 10-K Part IV\nINDEX TO EXHIBITS (CONTINUED) ITEM 14(c)\nExhibit No. 4(S) Indenture dated as of May 15, 1986 from the Company to Bankers Trust Company (See Amendment No. 1 to Registration No. 33-5350 Exhibit 4-A).\n4(T) Indenture dated as of December 1, 1992 from the Company to Bankers Trust Company. (See Registration No. 33-54936, Exhibit 4).\n4(U) Indenture dated as of August 15, 1993 from the Company to Bankers Trust Company. (See Registration No. 33-64476, Exhibit 4).\n10 Incentive Compensation Plan (filed as Exhibit 10(c) (vi) to United Telecommunications, Inc., Registration Statement No. 2-72988 and incorporated herein by reference).\n12 Computation of Ratio of Earnings to Fixed Charges.\n23 Consent of Ernst & Young.\nCarolina Telephone & Telegraph Company Form 10-K Part IV\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCAROLINA TELEPHONE AND TELEGRAPH COMPANY\nDate: March 9, 1994 By s/ F. E. Westmeyer --------------- ----------------------------------------- F. E. Westmeyer, Vice President-Finance\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nDate Signature and Title ---- -------------------\nMarch 9, 1994 s/ W. E. McDonald - -------------- -------------------------------------------- W. E. McDonald, President, Director and Chief Executive Officer\nMarch 9, 1994 s/ F. E. Westmeyer - -------------- -------------------------------------------- F. E. Westmeyer, Vice President-Finance\nMarch 9, 1994 s/ T. J. Geller - -------------- -------------------------------------------- T. J. Geller, Controller\nMarch 9, 1994 s/ F. J. Boling - -------------- -------------------------------------------- F. J. Boling, Jr, Director\nMarch 9, 1994 s/ T. G. Crewe - -------------- -------------------------------------------- T. G. Crewe, Jr, Director\nMarch 9, 1994 s/ E. I. Davis - -------------- -------------------------------------------- E. I. Davis, Director\nMarch 9, 1994 s/ N. B. DeFriece - -------------- -------------------------------------------- N. B. DeFriece, Director\nMarch 9, 1994 s/ C. D. Evans - -------------- -------------------------------------------- C. D. Evans, Director\nCarolina Telephone & Telegraph Company Form 10-K Part IV\nSIGNATURES (CONTINUED)\nDate Signature and Title ---- -------------------\nMarch 9, 1994 s/ J. A. Hackney, III - -------------- -------------------------------------------- J. A. Hackney, III, Director\nMarch 9, 1994 s/ W. P. Hendricks - -------------- -------------------------------------------- W. P. Hendricks, Director\nMarch 9, 1994 s/ J. W. Jones, Jr - -------------- -------------------------------------------- J. W. Jones, Jr, Director\nMarch 9, 1994 s/ J. A. Laughery - -------------- -------------------------------------------- J. A. Laughery, Director\nMarch 9, 1994 s/ G. W. Little - -------------- -------------------------------------------- G. W. Little, Director\nMarch 9, 1994 s/ B. R. McCain - -------------- -------------------------------------------- B. R. McCain, Director\nMarch 9, 1994 s/ J. M. Mead - -------------- -------------------------------------------- J. M. Mead, Director\n- -------------- -------------------------------------------- M. K. Norris, Director\nMarch 9, 1994 s/ D. W. Peterson - -------------- -------------------------------------------- D. W. Peterson, Director\n- -------------- -------------------------------------------- J. J. Powell, Director\nMarch 9, 1994 - -------------- -------------------------------------------- D. L. Ward, Jr, Director"},"word_count":{"kind":"number","value":11591,"string":"11,591"},"character_count":{"kind":"number","value":80457,"string":"80,457"}}},{"rowIdx":284,"cells":{"filename":{"kind":"string","value":"31277_1993.txt"},"id":{"kind":"string","value":"31277_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"31277"},"text":{"kind":"string","value":"Item 1. Business\nEaton Corporation (herein referred to as Eaton or Company) was incorporated in 1916. Eaton is a global manufacturer of vehicle powertrain components and a broad variety of controls serving transportation, industrial, commercial, aerospace, and military markets. The Company offers thousands of high-quality products worldwide. Principal products include truck transmissions and axles, engine components, electrical equipment and controls. The Company had 1993 net sales of $4.4 billion and 38,000 employees at 120 manufacturing facilities in 17 countries.\nIn May 1993, the Company redeemed its share purchase rights at a redemption price of 3-1/3 cents for each right, for a total payment of $2 million.\nIn June 1993, the Company distributed a two-for-one stock split effected in the form of a 100% stock dividend and increased its quarterly dividend on Common Shares to 30 cents per share from the post-split rate of 27-1/2 cents per share. Also, in June 1993, the Company reconsolidated the net assets and operating results of its remaining discontinued operations. The Company has concluded that, although it would still prefer to divest these operations, due to the ongoing contraction in the defense industry and uncertainty in the defense electronics market at the present time, it would be extremely difficult to implement its divestiture plans on an acceptable basis. Financial information for these operations is presented under Defense Systems in \"Business Segment Information\" on page 38 of this report.\nIn December 1993, the Company recorded a $55 million acquisition integration charge before income tax credits ($34 million after income tax credits, or $.49 per Common Share) in conjunction with the January 31, 1994 acquisition of the Distribution and Control Business Unit (DCBU) of Westinghouse Electric Corporation. The acquisition, which will be accounted for as a purchase in 1994, was for a purchase price of $1.1 billion, plus the assumption of certain liabilities. The purchase price is subject to adjustment based upon changes in DCBU's adjusted net assets. DCBU will be combined with the Company's Industrial Control and Power Distribution Operations, which market Cutler-Hammer products, to form a Cutler-Hammer business unit with annual sales of $1.6 billion. DCBU had 1993 sales of $1.1 billion and Eaton's consolidated sales are expected to increase 25% as a result of the acquisition. Further information regarding the acquisition and its financing is presented under \"Subsequent Event - Acquisition of DCBU and Integration Charge\" on pages 20 through 22 of this report.\nInformation regarding principal products, net sales, operating profit and identifiable assets by business segment and geographic region is found under \"Business Segment and Geographic Region Information\" on pages 35 to 39 of this report. Additional information regarding Eaton's business segments and its business in general is presented below.\nVehicle Components\nPatents and Trademarks - Eaton owns, controls or is licensed under many patents related to this business segment. Although Eaton emphasizes its EATON trademark in the marketing of many of its products within this business segment, it also markets under a number of other trademarks, including CHAR-LYNN, DILL, FULLER, ROADRANGER and TOP SPEC.\nSeasonal Fluctuations - Sales of truck, passenger car and off-highway vehicle components are generally reduced in the third quarter of each year as a result of preparations by vehicle manufacturers for the following model year and their temporary shut-downs for taking physical inventories.\nCompetition - The principal methods of competition in this business segment are price, service and product performance. Eaton occupies a strong competitive position in relation to its many competitors in this business segment and, with respect to many products, is considered among the market leaders.\nMajor Customers - Approximately 18% of net sales in 1993 of the Vehicle Components segment were made to divisions and subsidiaries of Ford Motor Company. Also, approximately 39% of net sales in 1993 of the Vehicle Components segment were made to divisions and subsidiaries of five other large companies. Eaton has been doing business with each of these companies for many years. Sales to these companies include a number of different products and different models or types of the same product, the sales of which are not dependent upon one another. With respect to many of the products sold, the various divisions and subsidiaries of each of the companies are in the nature of separate customers, and sales to one division or subsidiary are not dependent upon sales to other divisions or subsidiaries.\nElectrical and Electronic Controls\nPatents and Trademarks - Eaton owns, controls or is licensed under many patents related to this business segment. The EATON, C-H CONTROL, CUTLER-HAMMER, DOLE, DURANT, DYNAMATIC, HEINEMANN, KENWAY, and PANELMATE trademarks are used in connection with the marketing of products included in this business segment. In addition, in conjunction with its January 1994 acquisition of DCBU, the Company has the right to use the CHALLENGER, COMMANDER and WESTINGHOUSE trademarks in the marketing of certain products. The use of the WESTINGHOUSE trademark is limited to a period of ten years.\nCompetition - The principal methods of competition in this business segment are price, geographic coverage, service and product performance. The number of competitors varies with respect to the different products. Eaton occupies a strong competitive position in this business segment and, with respect to many products, is considered among the market leaders.\nMajor Customers - Approximately 8% of net sales in 1993 of the Electrical and Electronic Controls segment were made to the United States Government. All contracts that the Company has with the United States Government are subject to termination at the election of the Government. Approximately 6% of net sales in 1993 of the Electrical and Electronic Controls segment were made to divisions and subsidiaries of Ford Motor Company, which is a major customer of the Company's Vehicle Components segment.\nDefense Systems\nPatents and Trademarks - Eaton owns, controls or is licensed under many patents related to this business segment. The AIL, INCHWORM and HYPERMANUAL trademarks are used in connection with the marketing of products included in this business segment.\nCompetition - The principal methods of competition in this business segment are price, technological capability and product performance. The number of competitors is limited and varies with respect to the different technologies.\nMajor Customers - Almost all net sales in 1993 of the Defense Systems segment were made to the United States Government. All contracts that the Company has with the United States Government are subject to the termination at the election the Government.\nInformation Concerning Eaton's Business in General\nRaw Materials - The principal raw materials used by Eaton are iron, steel, copper, aluminum, brass, insulating materials, silver, rubber and plastic. These materials are purchased in various forms, such as pig iron, metal sheets and strips, forging billets, bar stock and plastic pellets. Eaton purchases its raw materials, as well as parts and other components, from many suppliers and under normal circumstances has no difficulty obtaining them.\nOrder Backlog - Since a significant proportion of open orders placed with Eaton by original equipment manufacturers of trucks, passenger cars and off-highway vehicles are historically subject to month-to-month releases by the customers during each model year, such orders are not considered technically firm. In computing its backlog of orders, Eaton includes only the amount of such orders released by such customers as of dates listed. Using this criterion, Eaton's total backlog was approximately $1 billion and $900 million as of December 31, 1993 and 1992, respectively. The backlog should not be relied upon as being indicative of results of operations for future periods.\nResearch and Development - Research and development expenses for new products and the improvement of existing products were $154 million in 1993, $151 million in 1992 and $138 million in 1991.\nProtection of the Environment - The operations of the Company involve the use, disposal and cleanup of certain substances regulated under environmental protection laws, as further discussed under \"Protection of the Environment\" on page 26 of this report. Subject to the difficulty in estimating future environmental costs, the Company expects that any sum it may have to pay in connection with environmental matters in excess of the amounts recorded or disclosed will not have a material adverse effect on its financial condition or results of operations. Eaton's estimated capital expenditures for environmental control facilities are not expected to be material for the remainder of 1994 and 1995.\nEmployees - Eaton employed 38,000 individuals as of December 31, 1993. As a result of its January 1994 acquisition of DCBU, the Company added 12,500 employees.\nItem 2.\n\n\nItem 2. Properties\nEaton's world headquarters is located in Cleveland, Ohio. The Company maintains manufacturing facilities at 120 locations in 17 countries. In addition, as a result of its January 1994 acquisition of DCBU, the Company acquired 36 manufacturing facilities in various domestic and international locations, as well as 27 satellite operations and 12 distribution centers. The Company is a lessee under a number of operating leases for certain real properties and equipment. Information regarding the Company's commitments for operating leases is found under \"Lease Commitments\" on page 28 of this report.\nEaton's principal research facilities are located in Southfield, Michigan, in Milwaukee, Wisconsin, and near Cleveland, Ohio. In addition, certain Eaton divisions conduct research in their own facilities.\nManagement believes that the Company's manufacturing facilities are adequate for its operations, and such facilities are maintained in good condition.\nItem 3.\nItem 3. Legal Proceedings\nNone required to be reported.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders\nNone.\nPart II\nItem 5.\nItem 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Company's Common Shares are listed for trading on the New York, Chicago, Pacific and London stock exchanges. Information regarding cash dividends paid and the high and low market price per Common Share for each quarter in 1993 and 1992 is found under \"Quarterly Data\" on page 34 of this report. At December 31, 1993, there were 15,417 holders of record of the Company's Common Shares. Additionally, 15,508 employees were shareholders through participation in the Company's Share Purchase and Investment Plan.\nItem 6.\nItem 6. Selected Financial Data\nInformation regarding selected financial data of the Company is found in the \"Five-Year Consolidated Financial Summary\" on page 49 of this report.\nItem 7.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" is found on pages 41 to 48 of this report.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data\nThe consolidated financial statements and financial review of Eaton Corporation and the report of independent auditors are found on pages 13 through 39 of this report.\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant\nThe information contained on pages 5 through 8 in the Company's definitive proxy statement dated March 18, 1994, with respect to directors of the Company, is incorporated herein by reference in response to this Item.\nThe following is a list of Eaton's officers, their ages and their current positions and offices, as of February 1, 1994.\nName Age Position (Date elected to position) - ---------------- --- ------------------------------------------- William E. Butler 62 Chairman and Chief Executive Officer (January 1, 1992); Director John S. Rodewig 60 President; Chief Operating Officer - Vehicle Components (September 22, 1993); Director Stephen R. Hardis 58 Vice Chairman and Chief Financial and Administrative Officer (April 23, 1986); Director Alexander M. Cutler 42 Executive Vice President; Chief Operating Officer - Controls (September 22, 1993); Director Gerald L. Gherlein 55 Executive Vice President and General Counsel (September 4, 1991) John M. Carmont 55 Vice President and Treasurer (December 1, 1981) Adrian T. Dillon 40 Vice President - Planning (March 1, 1991) Patrick X. Donovan 58 Vice President - International (April 27, 1988) John D. Evans 63 Vice President - Human Resources (January 1, 1982) Earl R. Franklin 50 Secretary and Associate General Counsel (September 1, 1991) John W. Hushen 58 Vice President - Corporate Affairs (August 1, 1991) Stanley V. Jaskolski 55 Vice President - Technical Management (October 1, 1990) Ronald L. Leach 59 Vice President - Accounting (December 1, 1981) William T. Muir 51 Vice President - Manufacturing Technologies (April 1, 1989) Derek R. Mumford 52 Vice President - Information Technologies (April 1, 1992) Billie K. Rawot 42 Vice President and Controller (March 1, 1991)\nAll of the officers listed above have served in various capacities with Eaton over the past five years. There are no family relationships among the officers listed, and there are no arrangements or understandings pursuant to which any of them were elected as officers. All officers hold office for one year and until their successors are elected and qualified, unless otherwise specified by the Board of Directors; provided, however, that any officer is subject to removal with or without cause, at any time, by a vote of a majority of the Board of Directors.\nItem 11.\nItem 11. Executive Compensation\nThe information contained on pages 11 through 25 in Eaton's definitive proxy statement dated March 18, 1994, with respect to executive compensation, is incorporated herein by reference in response to this Item.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nThe information contained on pages 28 and 29 of the Company's definitive proxy statement dated March 18, 1994, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference in response to this Item.\nItem 13.\nItem 13. Certain Relationships and Related Transactions\nThe information contained on page 10 of the Company's definitive proxy statement dated March 18, 1994, with respect to certain relationships and related transactions, is incorporated herein by reference in response to this Item.\nPart IV\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) (1) The following consolidated financial statements and financial review of Eaton Corporation are filed as a separate section of this report:\nConsolidated Balance Sheets - December 31, 1993 and 1992 - Pages 14 and 15\nStatements of Consolidated Income - Years ended December 31, 1993, 1992 and 1991 - Page 16\nStatements of Consolidated Cash Flows - Years ended December 31, 1993, 1992 and 1991 - Page 17\nStatements of Consolidated Shareholders' Equity - Years ended December 31, 1993, 1992 and 1991 - Page 18\nFinancial Review - Pages 19 to 39\n(2) The summarized financial information for Eaton ETN Offshore Ltd. on page 40 and the following consolidated financial statement schedules for Eaton Corporation are filed as a separate section of this report:\nSchedule V - Property, Plant and Equipment - Page 50\nSchedule VI - Accumulated Depreciation of Property, Plant and Equipment - Page 51\nSchedule IX - Short-Term Borrowings - Page 52\nSchedule X - Supplementary Income Statement Information - All other schedules for which provision is made in Regulation S-X of the Securities and Exchange Commission, are not required under the related instructions or are inapplicable and, therefore, have been omitted.\n(3) Exhibits\n3 Amended Articles of Incorporation (as amended and restated as of January 24, 1989, filed on Form SE on March 13, 1989) and Amended Regulations (as amended and restated as of April 27, 1988, filed on Form SE on March 13, 1989)\n4(a) Instruments defining rights of security holders, including indentures (Pursuant to Regulation S-K Item 601(b)(4), the Company agrees to furnish to the Commission, upon request, a copy of the instruments defining the rights of holders of long-term debt of the Company and its subsidiaries)\n10 Material contracts\n(1) DCBU Purchase Agreement dated as of August 10, 1993 between Westinghouse Electric Corporation (Seller) and Eaton Corporation (Buyer) Regarding the Distribution and Control Business Unit of Westinghouse Electric Corporation (Agreement) - Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993\nIncluding the following Exhibits to the Agreement: (i) Form of Technology Agreement (Ex. 2.1) (ii) Terms of Lease for Shared Facilities (Ex.9.6(a) (1)) (iii) Terms of Sublease for Shared Facilities (Ex. 9.6(a) (2)) (iv) Terms of Lease for Vidalia, Georgia Shared Facility (Ex. 9.6(b) (1) (i)) (v) Terms of Lease by Buyer of Part of Horseheads Facility (Ex. 9.6(b) (1) (ii)) (vi) Terms for Jackson, Mississippi Sublease (Ex. 9.6(b) (2)) (vii) Form of Services Agreement (Ex. 9.8) (viii) Form of WESCO Distributor Agreement (Ex. 9.9) (ix) Form of Interim NEWCO Distributor Agreement (Ex. 7.15.2) (x) Form of NEWCO Distributor Agreement (xi) Form of Supplier and Vendor Agreement (Ex. 9.10)\n(2) The following are either a management contract or a compensatory plan or arrangement:\n(a) Deferred Incentive Compensation Plan (as amended and restated May 1, 1990; filed as a separate section of this report)\n(b) Executive Strategic Incentive Plan, effective as of January 1, 1991 - Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992\n(c) Group Replacement Insurance Plan (GRIP), effective as of June 1, 1992 - Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992\n(d) 1991 Stock Option Plan - Incorporated herein by reference to the Company's definitive proxy statement dated March 18, 1991\n(e) The following are incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990:\n(i) Strategic Incentive and Option Plan (as amended and restated as of January 1, 1989)\n(ii) Limited Eaton Service Supplemental Retirement Income Plan (as amended and restated as of January 1, 1989)\n(iii) Amendments to the 1980 and 1986 Stock Option Plans\n(iv) Form of \"Change in Control\" Agreement entered into with all officers of Eaton Corporation\n(v) Eaton Corporation Supplemental Benefits Plan (as amended and restated as of January 1, 1989) (which provides supplemental retirement benefits)\n(vi) Eaton Corporation Excess Benefits Plan (as amended and restated as of January 1, 1989) (with respect to Section 415 limitations of the Internal Revenue Code)\n(f) The following are incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (filed on Form SE dated March 28, 1991):\n(i) Executive Incentive Compensation Plan\n(ii) Plan for the Deferred Payment of Directors' Fees (as amended and restated as of January 1, 1989)\n(iii) Plan for the Deferred Payment of Directors' Fees (originally adopted in 1980 and amended and restated in 1989)\n(iv) Eaton Corporation Retirement Plan for Non-Employee Directors (as amended and restated as of January 1, 1989)\n11 Statement regarding computations of net income per Common Share (filed as a separate section of this report)\n21 Subsidiaries of Eaton Corporation (filed as a separate section of this report)\n23 Consent of Independent Auditors (filed as a separate section of this report)\n24 Power of Attorney (filed as a separate section of this report)\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed during the fourth quarter of 1993.\n(c) & (d) Exhibits and Financial Statement Schedules\nCertain exhibits and financial statement schedules required by this portion of Item 14 are filed as a separate section of this report.\nSignatures\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nEaton Corporation -------------------- Registrant\nDate: March 28, 1994 /s/ Stephen R. Hardis --------------------- Stephen R. Hardis Vice Chairman and Chief Financial and Administrative Officer; Principal Financial Officer; Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nDATE: March 28, 1994\nSignature Title - -------------------- ------------------------------------- * - -------------------- William E. Butler Chairman and Chief Executive Officer; Principal Executive Officer; Director * - -------------------- John S. Rodewig President; Chief Operating Officer - Vehicle Components; Director\n* - -------------------- Alexander M. Cutler Executive Vice President; Chief Operating Officer - Controls; Director\n/s/ Ronald L. Leach - -------------------- Ronald L. Leach Vice President - Accounting; Principal Accounting Officer\n* - -------------------- Billie K. Rawot Vice President and Controller\n* - -------------------- Neil A. Armstrong Director\n* - -------------------- Phyllis B. Davis Director\n* - -------------------- Arthur Dole III Director\n* - -------------------- Charles E. Hugel Director\n* - -------------------- John R. Miller Director\n* - -------------------- Furman C. Moseley Director\n* - -------------------- Hooper G. Pattillo Director\n* - -------------------- A. William Reynolds Director\n* - -------------------- Gary L. Tooker Director\n*By /s/ Stephen R. Hardis -------------------------------------- Stephen R. Hardis, Attorney-in-Fact for the officers and directors signing in the capacities indicated\nEaton Corporation 1993 Annual Report on Form 10-K Items 6, 7, 8 & Item 14 (c) and (d)\nReport of Independent Auditors\nConsolidated Financial Statements and Financial Review\nSummary Financial Information for Eaton ETN Offshore Ltd.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nFive-Year Consolidated Financial Summary\nFinancial Statement Schedules\nExhibits\nREPORT OF INDEPENDENT AUDITORS - ------------------------------\nTo the Shareholders Eaton Corporation\nWe have audited the accompanying consolidated balance sheets of Eaton Corporation and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the summary financial information and financial statement schedules listed in Item 14(a). These financial statements, schedules and summary financial information are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements, schedules and summary financial information based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Eaton Corporation at December 31, 1993 and 1992, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related summary financial information and financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs described under \"Accounting Changes\" on page 22 of this report, in 1992 the Company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\nErnst & Young\nCleveland, Ohio February 1, 1994\nFINANCIAL REVIEW - ---------------- On June 28, 1993, the Company distributed a two-for-one stock split effected in the form of a 100% stock dividend. Accordingly, all per share amounts, average shares outstanding used in the calculation of per share amounts and stock option information have been adjusted retroactively to reflect the stock split.\nIn June 1993, the Company reconsolidated the net assets and operating results of its remaining discontinued operations. Prior years have been restated to include these results. The Company has concluded that, although it would still prefer to divest these operations, due to the ongoing contraction in the defense industry and uncertainty in the defense electronics market at the present time, it would be extremely difficult to implement its divestiture plans on an acceptable basis. Financial information for these operations is presented under Defense Systems in \"Business Segment Information\" in the Financial Review.\nACCOUNTING POLICIES - ------------------- Consolidation - ------------- The consolidated financial statements include accounts of the Company and all majority-owned subsidiaries. The equity method of accounting is used for investments where the Company has a 20% to 50% ownership interest.\nForeign Currency Translation - ---------------------------- Financial statements for subsidiaries outside the United States, except those in highly inflationary economies, are translated into U.S. dollars at year-end exchange rates as to assets and liabilities and weighted average exchange rates as to revenues and expenses. The resulting translation adjustments are recorded in shareholders' equity. Financial statements for subsidiaries in highly inflationary economies are translated into U.S. dollars in the same manner except for inventories and property, plant and equipment-net, and related expenses, which are translated at historical exchange rates. The resulting translation adjustments are included in net income.\nShort-Term Investments - ---------------------- Short-term investments are carried at cost and are not considered to be cash equivalents for purposes of classification in the statements of consolidated cash flows.\nInventories - ----------- Inventories are carried at lower of cost or market. Inventories in the United States, other than those associated with long-term contracts, are accounted for using the last-in, first-out (LIFO) method and all other inventories using the first-in, first-out (FIFO) method.\nLong-Term Contracts - ------------------- Income and costs on long-term contracts, which relate primarily to the Defense Systems business segment, are recognized on the percentage-of-completion method. Provision is made for anticipated losses on uncompleted contracts. Certain government contracts provide for incentive awards or penalties which are reflected in operations at the time amounts can be reasonably determined.\nDepreciation and Amortization - ----------------------------- Depreciation and amortization are computed by the straight-line method for financial statement purposes. Depreciation of plant and equipment is provided over the useful lives of the various classes of assets. Excess of cost over net assets of businesses acquired is amortized over fifteen to forty years (accumulated amortization was $78 million and $69 million at the end of 1993 and 1992, respectively). Other intangible assets, principally patents, are amortized over their respective lives.\nIncome Taxes - ------------ In 1992, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", as discussed under \"Accounting Changes\" in the Financial Review. Deferred income taxes are not provided for undistributed earnings of consolidated subsidiaries outside the United States when such earnings are reinvested for an indefinite period of time by the subsidiaries.\nFinancial Instruments - --------------------- Gains or losses on interest rate swap and cap agreements which hedge interest on debt are accrued in interest expense. Gains or losses on foreign currency forward exchange contracts and options which hedge specific transactions are recognized in net income, offsetting the underlying foreign currency transaction gains or losses. Gains or losses on foreign currency forward exchange contracts and options which hedge net investments in consolidated subsidiaries outside the United States are accrued in shareholders' equity. Premiums related to interest rate swap and cap agreements and foreign currency forward exchange contracts and options are amortized to net income over the life of the agreement.\nNet Income Per Common Share - --------------------------- Net income per Common Share is computed by dividing net income by the average month-end number of shares outstanding during each period. The dilutive effect of common stock equivalents is not material.\nSUBSEQUENT EVENT - ACQUISITION OF DCBU AND INTEGRATION CHARGE - ------------------------------------------------------------- On January 31, 1994, the Company acquired the Distribution and Control Business Unit (DCBU) of Westinghouse Electric Corporation for a purchase price of $1.1 billion, plus the assumption of certain liabilities. The purchase price is subject to adjustment based upon\nchanges in DCBU's adjusted net assets. This acquisition will be accounted for as a purchase in 1994. DCBU had sales of $1.1 billion in 1993 and has estimated net assets of $600 million. DCBU is a leading North American manufacturer of electrical distribution equipment and industrial controls, headquartered in Pittsburgh, Pennsylvania. It has approximately 12,500 employees who are located at 36 plants and facilities in the United States, Puerto Rico, Central and South America, Canada and the United Kingdom, and at 27 satellite operations and 12 distribution centers. The purchase includes Challenger Electrical Equipment Corporation, which was acquired by Westinghouse in 1987.\nDCBU will be combined with Eaton's Industrial Control and Power Distribution Operations (ICPDO), which market Cutler-Hammer products, to form a Cutler-Hammer business unit with annual sales of $1.6 billion. Eaton's consolidated sales are expected to increase by 25% as a result of the acquisition.\nIn order to finance the acquisition, the Company issued $930 million of short-term commercial paper. The Company plans to reduce these short-term financings by the middle of 1994 through equity and long-term debt financings. The timing and mix of these financings will depend on market conditions. Of these short-term financings, $555 million will be classified as long-term debt because the Company intends, and has the ability under a new five-year $555 million revolving credit agreement entered into in January 1994, to refinance this debt on a long-term basis. Also, in January 1994, the Company entered into a $555 million 364-day revolving credit agreement.\nIn 1993, the Company entered into several interest rate hedge agreements related to the planned financing of the acquisition. In September 1993, the Company entered into four interest rate swaps commencing on January 18, 1994. Two thirty-year swaps will effectively convert $100 million of floating rate debt into fixed rate debt at an average rate of 6.685%, and two ten-year swaps will effectively convert $100 million of floating rate debt into fixed rate debt at an average rate of 5.788%. In October 1993, the Company purchased a one-year interest rate cap commencing on January 1, 1994 that effectively places a 5.5% ceiling on $400 million of floating rate debt, and a ten-month interest rate cap commencing January 1, 1995 that effectively places a 5.5% ceiling on $100 million of floating rate debt.\nIn December 1993, in conjunction with the acquisition, the Company recorded a $55 million acquisition integration charge before income tax credits ($34 million after income tax credits, or $.49 per Common Share). Part of a comprehensive business plan, the charge addresses the costs of the integration of ICPDO product lines and operations with DCBU, related workforce reductions and an $8 million write-down of assets, largely in the United States. Expenditures are expected to occur over approximately the next four years and will be funded through cash flow from the combined operations. The Company anticipates that integration of the businesses will create permanent value by streamlining product lines, manufacturing capacity and\norganization structure and enable the businesses to attain maximum benefit from synergy of complementary product offerings, operations and technical expertise. Positive incremental benefits are anticipated following the first year of integration activities.\nEXTRAORDINARY ITEM AND RESTRUCTURING CHARGE - ------------------------------------------- In March 1993, the Company called for redemption, in April 1993, the $74 million outstanding balance of its 9% debentures, and in December 1993, the Company called for redemption, in January 1994, the $89 million outstanding balance of its 8.5% debentures. The extraordinary loss on these redemptions, including the write-off of debt issue costs, was $11 million before income tax credits ($7 million after income tax credits, or $.10 per Common Share).\nIn 1991, as a result of the review of operating strategies and in order to improve competitiveness and future profitability, the Company recorded a restructuring charge of $39 million before income tax credits ($25 million after income tax credits, or $.38 per Common Share). The charge included provisions for restructuring, relocation and rationalization of product lines and operations and permanent workforce reductions involving a significant number of operations, primarily in the United States and Europe.\nACCOUNTING CHANGES - ------------------ In 1992, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". SFAS No. 106 requires accrual of these benefits, primarily postretirement health care and life insurance for retirees in the United States, over the working lives of employees rather than recognition of expenses as claims are incurred. Included in net income for 1992 is the cumulative effect of this accounting change for prior years of $442 million before income tax credits ($274 million after income tax credits, or $3.97 per Common Share). As a result of this accounting change, 1992 postretirement health care and life insurance costs increased $25 million before income tax credits ($16 million after income tax credits, or $.23 per Common Share). Results for 1991 have not been restated for this accounting change. SFAS No. 106 has no effect on cash flows since claims will continue to be paid as incurred.\nIn 1992, the Company also adopted SFAS No. 109, \"Accounting for Income Taxes\". The adoption of this standard changed the method of accounting for income taxes to the liability method from the deferred method. The liability method requires recognition of deferred income taxes based on temporary differences between the financial reporting and income tax bases of assets and liabilities, using currently- enacted income tax rates and regulations. Included in net income for 1992 is the cumulative effect of this accounting change for prior years of $6 million, or $.09 per Common Share. Results for 1991 have not been restated for this accounting change. SFAS No. 109 has no effect on cash flows.\nACCOUNTS RECEIVABLE - ------------------- Included in accounts receivable at December 31, 1993 and 1992 were unbilled amounts of $23 million and $91 million, respectively, primarily related to long-term contracts of the Defense Systems business segment with the United States Government. These receivables will be billed in accordance with applicable contract terms and are expected to be collected within one year.\nAccounts receivable are net of an allowance for doubtful accounts of $10 million at the end of 1993 and 1992.\nINVENTORIES - ----------- December 31 --------------- (Millions of dollars) 1993 1992 ---- ---- Raw materials $141 $128 Work in process 238 264 Finished goods 139 146 ---- ---- Gross inventories at FIFO 518 538 Excess of current cost over LIFO cost (84) (83) ---- ---- Net inventories at LIFO $434 $455 ==== ====\nGross inventories accounted for using the LIFO method were $314 million and $294 million at the end of 1993 and 1992, respectively.\nDEBT AND OTHER FINANCIAL INSTRUMENTS - ------------------------------------ Information related to the 1994 financing of the acquisition of DCBU is contained under \"Subsequent Event - Acquisition of DCBU and Integration Charge\" in the Financial Review.\nThe Company has lines of credit, primarily short-term, aggregating $119 million from various banks worldwide. Most of these arrangements do not have termination dates, but are reviewed periodically for renewal. At December 31, 1993, the Company had $24 million outstanding under lines of credit with banks.\nA summary of long-term debt, excluding the current portion, follows:\nDecember 31 --------------- (Millions of dollars) 1993 1992 ---- ---- 9% notes payable, due 2001 $100 $100 8% debentures, due 2006 (due 1996 at option of debenture holder) 86 86 8.9% debentures, due 2006 100 100 7% debentures, due 2011, net of unamor- tized discount of $95 million in 1993 and $96 million in 1992 (effective interest rate 14.6%) 105 104 8-7/8% debentures, due 2019 (due 2004 at option of debenture holder) 38 38 8.1% debentures, due 2022 100 100 Notes payable of Employee Stock Ownership Plan due through 1999 82 96 8.5% sinking fund debentures 89 9% sinking fund debentures 74 Other 38 46 ---- ---- $649 $833 ==== ====\nDuring 1993, the Company called for redemption the $74 million outstanding balance of its 9% debentures and the $89 million outstanding balance of its 8.5% debentures, resulting in an extraordinary loss of $7 million.\nNotes payable of the Employee Stock Ownership Plan (ESOP), which are guaranteed by the Company, consist of $65 million at a floating interest rate (3.00% at December 31, 1993) based on LIBOR and $31 million at a fixed interest rate of 7.62%. The Company has entered into a series of interest rate swaps, which expire ratably through 1999, and which change the interest rate on the $31 million of fixed interest rate notes payable to fixed interest rates of 7.07% and 6.85% as to $9 million and $18 million, respectively, and to a floating interest rate (2.075% at December 31, 1993) based on LIBOR as to $4 million.\nIn 1991, an unrelated party exercised its option under a 1990 agreement to enter into an interest rate swap expiring in 2000 with the Company. The agreement effectively converts $100 million of floating rate debt into fixed rate obligations. Payments are received at a floating interest rate (3.375% at December 31, 1993) based on LIBOR and are made at a fixed interest rate of 9%.\nAggregate mandatory sinking fund requirements and annual maturities of long-term debt are as follows (in millions): 1994, $110; 1995, $21; 1996, $106; 1997, $21; and 1998, $22. The amount for 1994 includes $89 million of 8.5% debentures called for redemption in January 1994. The amount for 1996 includes $86 million of 8% debentures due in 1996 at the option of the debenture holder.\nInterest cost capitalized as part of acquisition or construction of major assets (in millions) was $12, $8, and $7 in 1993, 1992 and 1991, respectively. Interest paid (in millions) was $90, $94 and $81 in 1993, 1992 and 1991, respectively.\nAt December 31, 1993, the Company held foreign currency forward exchange contracts and options, which primarily mature in 1994, for purchase or sale of largely European and Canadian currencies to hedge foreign currency transactions and net investment positions. Open purchase contracts totaled $63 million and open sales contracts totaled $290 million.\nCounterparties to various hedging instruments are a number of major international financial institutions. While the Company may be exposed to credit losses in the event of nonperformance by these counterparties, it does not anticipate losses due to its control over the limit of positions entered into with any one party and the strong credit ratings of these institutions.\nThe following table summarizes the carrying amount and fair value of financial instruments:\nThe fair value of equity investments, marketable securities, long-term debt and interest rate derivatives was principally based on quoted market prices. The fair value of foreign currency forward exchange contracts and options was estimated based on quoted market prices of comparable contracts, adjusted through interpolation where necessary for maturity differences. The carrying amount of financial instruments is not affected by the fair value measurement.\nPROTECTION OF THE ENVIRONMENT - ----------------------------- The Company has been named a potentially responsible party (PRP) under the Federal Superfund law at a number of waste disposal sites. Although this law technically imposes joint and several liability upon each PRP at each site, the extent of the Company's required financial contribution to the cleanup of these sites is expected to be limited based on the number and financial strength of the other named PRP's and the volumes of waste involved which might be attributable to the Company. The Company is also involved in remedial response and voluntary environmental cleanup expenditures at a number of other sites which are not the subject of any Superfund law proceeding, including certain of its currently-owned or formerly-owned plants. Although it is difficult to quantify the potential financial impact of compliance with environmental protection laws, management estimates that there is a reasonable possibility that the remediation and other costs associated with all of these sites may range between $10 million and $68 million, and that such costs would be incurred over a period of several years. The Company accrues for these costs when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. At December 31, 1993, the Company's balance sheet included an accrual for the estimated remediation and other environmental costs of approximately $14 million. Actual costs to be incurred at identified sites in future periods may vary from the estimates, given inherent uncertainties in evaluating environmental exposures. Subject to the difficulty in estimating future environmental costs, the Company expects that any sum it may be required to pay in connection with environmental matters in excess of the amounts recorded or disclosed above will not have a material adverse effect on its financial condition or results of operations.\nWith respect to the DCBU operations acquired at January 31, 1994, to date the Company has conducted only a due diligence, pre-acquisition review of the environmental loss contingencies and expenditures at these operations. Although additional investigation and review is in progress, the Company is not yet able to evaluate conclusively the scope of any environmental issues. The Company expects that these operations will have environmental exposure similar to that of other electrical equipment manufacturers. The Company's exposure is limited, however, by the agreement between the Company and Westinghouse Electric Corporation, pursuant to which the Company acquired DCBU. With respect to environmental conditions existing prior to the acquisition, Westinghouse has agreed to retain certain responsibilities, to share the cost of others and to indemnify the Company for its share of those costs to the extent that they exceed $3.5 million annually. For locations in the United States, this obligation to share and to indemnify extends for ten years, and for locations elsewhere it extends for fifteen years.\nThe Company continues to modify, on an ongoing, regular basis, certain of its processes in order to reduce the impact on the environment. Efforts in this regard include the removal of many underground storage tanks and the reduction or elimination of certain chemicals and wastes in its operations.\nOPTIONS FOR COMMON SHARES - ------------------------- Options have been granted to certain employees, under various plans, to purchase the Company's Common Shares at prices equal to fair market value as of date of grant. These options expire ten years from date of grant. A summary of stock option activity follows:\nSHAREHOLDERS' EQUITY - -------------------- There are 150 million Common Shares authorized. There were 11 million and 12 million Common Shares held in treasury at the end of 1992 and 1991, respectively, which were reissued in conjunction with the June 1993 two-for-one stock split. At December 31, 1993, 5.8 million Common Shares were reserved principally for exercise and grant of stock options. At December 31, 1993, there were 15,417 holders of record of Common Shares. Additionally, 15,508 employees were shareholders through participation in the Share Purchase and Investment Plan.\nIn private placements the Company sold 1.3 million Common Shares in 1993 for aggregate net proceeds of $62 million, and sold an additional 800,000 Common Shares in January 1994 for aggregate net proceeds of $38 million. In May 1993, the Company redeemed its share purchase rights at a redemption price of 3-1/3 cents for each right, for a total payment of $2 million.\nThe Company's Employee Stock Ownership Plan (ESOP) was established to prefund a portion of the anticipated matching contributions through 1999 to its Share Purchase and Investment Plan (SPIP) for participating United States employees. That portion of SPIP expense related to the ESOP is calculated by first determining the ratio of shares allocated to employee ESOP accounts relative to shares released, and then applying that ratio to the amount contributed to the ESOP. That amount, along with dividends on unallocated Common Shares held by the ESOP, is used to repay the notes, including interest, in level installments. Unallocated ESOP shares are allocated to employee ESOP accounts in aggregate amounts based on loan principal payments made by the ESOP.\nLEASE COMMITMENTS - ----------------- Future minimum rental commitments as of December 31, 1993, under noncancelable operating leases, which expire at various dates and in most cases contain renewal options, are as follows (in millions): 1994, $28; 1995, $23; 1996, $17; 1997, $14; 1998, $12; and after 1998, $91.\nRental expense in 1993, 1992 and 1991 (in millions) was $43, $45 and $49, respectively.\nPENSION PLANS - ------------- The Company has non-contributory defined benefit pension plans covering the majority of employees. Plans covering salaried and certain hourly employees provide benefits that are generally based on years of service and final average compensation. Benefits for other hourly employees are generally based on years of service. Company policy is to fund at least the minimum amount required by applicable regulations. In the event of a change in control of the Company, excess pension plan assets of North American operations may be dedicated to funding of health and welfare benefits for employees and retirees.\nThe components of pension (expense) income are as follows:\nYear ended December 31 -------------------------- (Millions of dollars) 1993 1992 1991 ---- ---- ---- Service cost - benefits earned during year $(42) $(39) $(39) Interest cost on projected benefit obligation (97) (96) (92) Actual return on assets 155 203 216 Net amortization and deferral (17) (73) (90) ---- ---- ---- $ (1) $ (5) $ (5) ==== ==== ====\nThe following table sets forth, by funded status, the asset (liability) recognized in the consolidated balance sheets for pension plans:\nMeasurement of the projected benefit obligation was based on a discount rate of 7.25% in 1993 and 8.25% in 1992 and 1991. The expected compensation growth rate was 4.95% in 1993 and 5.95% in 1992 and 1991. The expected long-term rate of return on assets was 10% in all three years; actual returns during each of these three years exceeded the expected 10% rate. Plan assets were invested in equity and fixed income securities and other instruments. Underfunded plans are associated principally with operations outside the United States. The change in the discount rate to 7.25% at the end of 1993 had the effect of increasing the accumulated pension benefit obligation by $103 million with an offsetting decrease in the unamortized net gain. This change will have an immaterial effect on future expense.\nPOSTRETIREMENT BENEFIT PLANS OTHER THAN PENSIONS - ------------------------------------------------ Generally, employees become eligible for postretirement benefits other than pensions, primarily health care and life insurance for retirees in the United States, when they retire. These benefits are payable for life, although the Company retains the right to modify or terminate the plans providing these benefits. The plans are primarily contributory, with retiree contributions adjusted annually, and contain other cost-sharing features, including deductibles and co-payments. Effective January 1, 1993, certain plans were amended to limit the annual amount of the Company's future contributions towards employees' postretirement health care benefits. Company policy is to pay claims as they are incurred since, unlike pensions, there is no effective method to obtain a tax deduction for prefunding of these benefits under existing United States income tax regulations.\nExpense for postretirement benefits other than pensions, with amounts for 1993 and 1992 calculated under SFAS No. 106, is as follows:\nYear ended December 31 ---------------------- (Millions of dollars) 1993 1992 1991 ---- ---- ---- Service cost - benefits earned during year $ (7) $(12) Interest cost on projected benefit obligation (37) (44) Amortization of unrecognized prior service cost 9 Claims incurred and expensed $(27) ---- ---- ---- $(35) $(56) $(27) ==== ==== ====\nThe liability recognized in the consolidated balance sheets for postretirement benefit plans other than pensions is as follows:\nDecember 31 --------------- (Millions of dollars) 1993 1992 ---- ---- Accumulated postretirement benefit obligation Retirees $368 $345 Eligible plan participants 38 45 Noneligible plan participants 120 161 Unamortized amounts not yet recognized Prior service cost 91 Net loss (73) (5) ---- ---- $544 $546 ==== ====\nMeasurement of the accumulated postretirement benefit obligation at December 31, 1993, was based on a 12% annual rate of increase in per capita cost of covered health care benefits (13% for 1992). For 1993, the rate was assumed to decrease ratably to 5% through 2000 and remain at that level thereafter (6% for 1992). The discount rate was 7.25% in 1993 and 8.5% in 1992. An increase of 1% in assumed health care cost trend rates would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $34 million and the net periodic cost for 1993 by $2 million. The changes in assumed rates had the effect of increasing the accumulated postretirement benefit obligation by $49 million with an offsetting increase in the unamortized net loss. This change will have an immaterial effect on future expense.\nINVESTMENT IN LIFE INSURANCE - ---------------------------- In 1993, the Company purchased company-owned life insurance policies insuring the lives of a portion of its active United States employees. These policies offer an attractive means of accumulating assets to meet future liabilities including the payment of employee benefits such as health care. At December 31, 1993, the investment in this life insurance, included in other assets, was $7 million, net of policy loans of $110 million. Net life insurance expense of $2 million, including interest expense of $4 million in 1993, was included in selling and administrative expense.\nINCOME TAXES - ------------ Year ended December 31 ---------------------- (Millions of dollars) 1993 1992 1991 ---- ---- ---- Income before income taxes United States $214 $147 $ 85 Outside the United States 48 34 16 ---- ---- ---- $262 $181 $101 ==== ==== ====\nIncome taxes, with amounts for 1993 and 1992 derived under SFAS No. 109, are summarized below:\nYear ended December 31 ---------------------- (Millions of dollars) 1993 1992 1991 ---- ---- ---- Current United States Federal $108 $ 42 $ 64 State and local 7 5 10 Outside the United States 30 20 10 ---- ---- ---- 145 67 84\nDeferred United States Increase in statutory tax rate (5) Other Federal (50) (14) (47) State and local (2) (1) (8) Outside the United States Operating loss carryforwards (7) (11) Reduction of valuation allowance for deferred tax assets (5) Increase in statutory tax rate (1) Other 7 (2) ---- --- --- (63) (26) (57) ---- --- --- $ 82 $41 $27 ==== === === Significant components of net current and net long-term deferred income taxes derived under SFAS No. 109 are as follows:\nDecember 31, 1993 -------------------------------\nCurrent Long-term Long-term (Millions of dollars) assets assets liabilities ------- --------- ----------- Accruals and other adjustments Employee benefits $ 44 $209 $ (4) Inventory 15 Long-term contracts 16 Restructuring 15 13 Depreciation and amortization (140) (15) Other 22 5 Operating loss carryforwards 50 2 Valuation allowance (15) Other items 15 (10) 7 ---- ---- ---- $127 $112 $(10) ==== ==== ====\nDecember 31, 1992 -------------------------------\nCurrent Long-term Long-term (Millions of dollars) assets assets liabilities ------- --------- ----------- Accruals and other adjustments Employee benefits $ 28 $209 $ (3) Inventory 26 Long-term contracts 17 (9) Restructuring 14 Depreciation and amortization (137) (19) Other 23 4 Operating loss carryforwards 42 4 Valuation allowance (20) Other items 12 (28) 4 ---- ---- ---- $120 $ 61 $(14) ==== ==== ====\nThe deferred income tax provision of $57 million for 1991 related primarily to long-term contracts.\nAt December 31, 1993 certain subsidiaries outside the United States had tax loss carryforwards aggregating $115 million. Carryforwards of $68 million have no expiration dates and the balance expire at various dates from 1995 through 2005.\nThe adoption of SFAS No. 109 reduced 1992 income tax expense by $11 million and the effective income tax rate by 6%, in comparison to the prior accounting method.\nThe parent company has not provided income taxes on undistributed earnings of consolidated subsidiaries outside the United States of $332 million at December 31, 1993, since the earnings retained have been reinvested by the subsidiaries. If distributed, such remitted earnings would be subject to withholding taxes but substantially free of United States income taxes.\nWorldwide income tax payments, including Federal and state income taxes in the United States, in 1993, 1992 and 1991 (in millions) were $156, $71 and $97, respectively.\nQUARTERLY DATA - -------------- (Unaudited) Quarter ended (Millions of dollars except ----------------------------------- for per share data) Dec. 31 Sept. 30 June 30 Mar. 31 ------- -------- ------- ------- Net sales $1,115 $1,053 $1,147 $1,086 Gross margin 297 266 279 275 Percent of sales 27% 25% 24% 25% Income before extraordinary item 30 44 53 53 Extraordinary item (4) (3) Net income 26 44 53 50\nPer Common Share Income before extraordinary item $ .41 $ .63 $ .77 $ .76 Extraordinary item (.05) (.05) Net income .36 .63 .77 .71 Cash dividends paid .30 .30 .275 .275 Market price High 55-3/8 51-3/4 47-1/8 43-3/4 Low 48 43 41-1/2 38-1/4\nNet sales $1,030 $1,012 $1,064 $ 995 Gross margin 253 223 256 235 Percent of sales 24% 22% 24% 24% Income before cumulative effect of accounting changes 39 28 41 32 Cumulative effect of accounting changes Postretirement benefits other than pensions (274) Income taxes 6 Net income (loss) 39 28 41 (236)\nPer Common Share Income before cumulative effect of accounting changes $ .57 $ .40 $ .60 $ .46 Cumulative effect of accounting changes Postretirement benefits other than pensions (4.00) Income taxes .09 Net income (loss) .57 .40 .60 (3.45) Cash dividends paid .275 .275 .275 .275 Market price High 40-7/8 40-3/8 41-5/8 39-3/8 Low 35 35-7/8 35-1/2 30-7/8\nThe fourth quarter of 1993 includes an acquisition integration charge of $55 million before income tax credits ($34 million after income tax credits, or $.49 per Common Share).\nThe redemption of debentures in 1993 resulted in extraordinary losses of $5 million and $6 million before income tax credits in the first and fourth quarters, respectively ($3 million and $4 million after income tax credits, or $.05 per Common Share in each quarter). The previously reported first quarter results were restated to segregate the extraordinary loss.\nGross margin for the second quarter of 1993 was reduced by a charge of $9 million for the restructuring of certain vehicle components operations in Europe.\nThe third quarter of 1992 includes an $11 million gain, before income taxes, on the sale of an interest in a limited partnership. The gain was partially offset by the accrual in the third quarter of 1992 of the contribution to the Company's charitable trust of marketable securities with a market value of $8 million.\nIn 1992, the Company adopted the new accounting standards for postretirement benefits other than pensions and income taxes, retroactive to January 1, 1992. Net income in the first quarter of 1992 includes the cumulative effect of the accounting change for postretirement benefits other than pensions for prior years of $442 million before income tax credits ($274 million after income tax credits, or $4.00 per Common Share). Net income in the first quarter of 1992 also includes the cumulative effect of the accounting change for income taxes for prior years of $6 million, or $.09 per Common Share.\nBUSINESS SEGMENT AND GEOGRAPHIC REGION INFORMATION - -------------------------------------------------- Operations are classified among three business segments: Vehicle Components, Electrical and Electronic Controls and Defense Systems. The major classes of products included in each segment and other information follow.\nVehicle Components - ------------------ Truck Components - Heavy and medium duty mechanical transmissions; power take-offs; drive, trailer and steering axles; brakes; locking differentials; engine valves; valve lifters; leaf springs; viscous fan drives; fans and fan shrouds; power steering pumps; tire pressure control systems; tire valves.\nPassenger Car Components - Engine valves; hydraulic valve lifters; viscous fan drives; fans and fan shrouds; locking differentials; spring fluid dampers; superchargers; tire valves.\nOff-Highway Vehicle Components - Mechanical and automatic transmissions; drive and steering axles; brakes; engine valves; hydraulic valve lifters; gear and piston pumps and motors; transaxles and steering systems; geroters; control valves and cylinders; forgings; tire valves.\nThe principal market for these products is original equipment manufacturers of trucks, passenger cars and off-highway vehicles. Most sales of these products are made directly from the Company's plants to such manufacturers.\nElectrical and Electronic Controls - ---------------------------------- Industrial and Commercial Controls - Electromechanical and electronic controls: motor starters, contactors, overloads and electric drives; programmable controllers, counters, man/machine interface panels and pushbuttons; photoelectric, proximity, temperature and pressure sensors; circuit breakers; loadcenters; safety switches; panelboards; switchboards; dry type transformers; busway; meter centers; portable tool switches; commercial switches; relays; illuminated panels; annunciator panels; electrically actuated valves and actuators.\nAutomotive and Appliance Controls - Electromechanical and electronic controls: convenience, stalk and concealed switches; knock sensors; climate control components; speed controls; timers; pressure switches; water valves; range controls; thermostats; gas valves; infinite switches; temperature and humidity sensors.\nSpecialty Controls - Automated material handling systems; automated guided vehicles; stacker cranes; ion implanters; engineered fasteners; golf grips; industrial clutches and brakes.\nThe principal markets for these products are industrial, commercial, automotive, appliance, aerospace and government customers. Sales are made directly by the Company or indirectly through distributors and manufacturers' representatives.\nDefense Systems - --------------- Strategic countermeasures; tactical jamming systems; electronic intelligence; electronic support measures.\nThe principal market for these products is the United States Government.\nOther Information - ----------------- Operating profit represents net sales less operating expenses for each segment and geographic region and excludes interest expense and income, and general corporate expenses--net.\nIdentifiable assets for each segment and geographic region represent those assets used in operations (including excess of cost over net assets of businesses acquired) and exclude general corporate assets (consisting principally of short-term investments, deferred income taxes, investments carried at equity, property and other assets).\nNet sales to divisions and subsidiaries of one customer, primarily from the Vehicle Components business segment, were $541 million in 1993, $491 million in 1992 and $394 million in 1991 (12% of sales in 1993, 12% in 1992 and 11% in 1991).\nGeographic Region Information\nSummary Financial Information for Eaton ETN Offshore Ltd. - ---------------------------------------------------------\nEaton ETN Offshore Ltd. (Eaton Offshore) was incorporated by Eaton under the laws of Ontario, Canada, primarily for the purpose of raising funds through the offering of debt securities in the United States and making these funds available to Eaton and/or one or more of Eaton's direct or indirect subsidiaries. All of the issued and outstanding capital stock of Eaton Offshore is owned directly or indirectly by Eaton. In addition, Eaton Offshore owns all of the issued and outstanding capital stock of Eaton Yale ltd. (Eaton Yale) previously owned by Eaton. Eaton Yale is engaged principally in the manufacture of fasteners, leaf spring assemblies and electrical and electronic controls. In January 1992, Eaton Yale acquired Franz Kirsten KG. In January 1994, Eaton Yale acquired the Canadian operations of the Distribution and Control Business Unit of the Westinghouse Electric Corporation. Summary financial information for Eaton Offshore and its consolidated subsidiaries is as follows:\nYear ended December 31 ------------------------------------ (Millions of dollars) 1993 1992 1991 1990 1989 ---- ---- ---- ---- ----\nIncome statement data Net sales $281 $295 $165 $188 $207 Gross profit 38 42 26 29 29 Net income 13 17 13 12 7\nBalance sheet data Current assets $144 $144 $124 $ 91 $ 49 Net intercompany receivables (payables) 22 24 33 17 (11) Noncurrent assets 81 86 42 48 45 Current liabilities 42 51 20 21 12 Noncurrent liabilities 109 115 104 73 12\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW - -------- The Company experienced an extraordinary year of achievement in 1993.\nIncome after income taxes for the year increased to $214 million in 1993 before the recognition of a $34 million acquisition integration charge and a $7 million extraordinary loss on the redemption of debentures. This represents a 53% increase compared to income of $140 million in 1992 (before the cumulative effect of 1992 accounting changes). Earnings per Common Share, before the special charges, rose to $3.06 in 1993, a 51% increase over $2.03 (before the impact of accounting changes) in 1992.\nOn January 31, 1994, the Company acquired Westinghouse Electric Corporation's Distribution and Control Business Unit (DCBU), and in December of 1993 recorded a $55 million charge ($34 million after income tax credits, or $.49 per Common Share) for the integration of the Company's Industrial Control and Power Distribution Operations (ICPDO) with DCBU to form the Cutler- Hammer business unit. This acquisition provides greater product depth with world class technology and substantially increases product offering and distribution opportunities.\nDuring March and December 1993, the Company called for redemption a total of $163 million of debentures. The loss on the redemptions was accounted for as an extraordinary item in each of those periods. In June, a two-for-one common stock split was distributed, effected in the form of a 100% stock dividend, and the quarterly dividend on Common Shares was increased by 2-1/2 cents (9%) to 30 cents per share, the third dividend increase in seven years.\nIn June, the Company reconsolidated the net assets and operating results of its remaining discontinued operations. Prior years have been restated to include those results.\n1993 COMPARED TO 1992 - --------------------- NET SALES - --------- Net sales in 1993 increased by 7% to $4.40 billion, over $4.10 billion in 1992. The increase occurred principally in the United States and was largely due to a strengthened North American market for heavy and light trucks, vans and sport utility vehicles, responding to a U.S. economic recovery. The improvement in North America more than offset the effects of the continued deep European recession. In North America, certain\nmarkets, which had been sluggish through most of 1993, showed sales improvements in the fourth quarter.\nThe Vehicle Components segment net sales increased to $2.36 billion for 1993, rising 13% over 1992 sales of $2.09 billion. This improvement was largely due to significant growth in sales of truck components, following the best factory sales of heavy trucks in North America since 1979. The passenger car and light truck markets also showed improvement in 1993. Off-highway equipment markets, which had been down for several years, improved considerably. Strong sales growth in North America was partially offset by reduced sales in Europe where vehicle markets remain weak.\nThe Electrical and Electronic Controls segment showed a net sales increase of 4% in 1993 to $1.85 billion compared to $1.78 billion in 1992. This increase was largely due to increased sales in the areas of industrial and commercial controls and specialty controls. Strong North American markets for automotive and appliance controls were largely offset, however, by the continued weakness in the corresponding European markets due to the economic recession and the negative impact of foreign currency exchange rate fluctuations. Rising demand for portable tools, factory equipment and residential housing drove the increase in sales of industrial and commercial controls. Sales of the Company's industrial and power distribution equipment, which tend to lag any North American economic recovery, rose sharply in the fourth quarter. The semiconductor equipment business, included in specialty controls, experienced strong results throughout the year, with a 19% improvement in sales for 1993 over 1992.\nOPERATING RESULTS - ----------------- Gross margin increased to $1.12 billion (25.4% of sales) in 1993, rising from $967 million (23.6% of sales) in 1992, due to significant sales growth as well as benefits achieved through ongoing cost containment and productivity improvements. This improvement in margin was achieved in spite of a $9 million charge, included in cost of products sold in 1993, for the restructuring of certain vehicle components operations in Europe.\nSelling and administrative expenses showed an increase of 2% in 1993 compared to 1992, with expense of $591 million in 1993 and $578 million in 1992. This level of increase is a clear indication of the results of cost control and restructuring efforts, which is further evidenced by their relationship to net sales, 13% in 1993 compared to 14% in 1992.\nResearch and development expenses for 1993 were $154 million, rising from $151 million in 1992. This level of expenditure reflects the continued commitment to achieving expressed\ncorporate targets in product innovation and enhancements and to maintaining leading-edge technology.\nThe Vehicle Components segment operating profit rose to $247 million (10% of sales) for 1993, a substantial improvement over $170 million (8% of sales) for 1992 despite a $9 million restructuring charge recorded in 1993 for restructuring certain European operations. This improvement was largely a result of the improved market in North America for heavy and light trucks, vans and sport utility vehicles. Other factors contributing to increased profits were continuing stringent cost containment efforts and the economies achieved through restructuring certain businesses, which have better positioned operations to benefit from further growth in vehicle markets.\nThe Electrical and Electronic Controls segment operating profit significantly improved, before the effect of the $55 million acquisition integration charge, rising 62% to $138 million in 1993 (7% of sales) from $85 million (5% of sales) in 1992. This improved segment profit picture is partially due to the sales growth experienced in certain controls markets, but is also a clear reflection of the continuing emphasis placed on containing and controlling costs and the realization of anticipated benefits of earlier restructuring efforts. The depressed European economy negatively impacted the controls businesses, particularly automotive and appliance controls. Profit for this segment was also reduced by a $55 million pretax charge recorded in December 1993 for the integration of ICPDO product lines and operations with DCBU to form the new Cutler-Hammer business unit. The DCBU acquisition will bring a more even balance in sales and earnings between the Electrical and Electronic Controls segment and the historically strong Vehicle Components segment.\nInterest expense declined to $75 million for 1993, the lowest level since 1986, from $89 million for 1992 largely due to the reduction of higher interest rate debt, lower debt levels during 1993 and increased capitalized interest.\nOther income--net was $12 million in 1993, down from $23 million in 1992, largely due to the $11 million pretax gain on the sale of the Company's interest in a limited partnership recorded in 1992.\nAn analysis of changes in income taxes and the effective income tax rate is presented under \"Income Taxes\" in the Financial Review.\nIn 1992, the Company adopted two new accounting standards for postretirement benefits other than pensions and for income taxes, which together reduced net income by $268 million due to the recognition of their cumulative effect for prior years.\nCHANGES IN FINANCIAL CONDITION - ------------------------------ The Company's financial condition remained strong during 1993. The current ratio was 1.9 at December 31, 1993 compared to 2.0 at December 31, 1992. The decline in working capital to $679 million at year-end 1993 from $751 million at year-end 1992 was primarily the result of an increase in the current portion of long-term debt due to the decision to redeem, in early 1994, the $89 million outstanding balance of 8.5% debentures. Cash and short-term investments increased by $84 million to $300 million at December 31, 1993 due to improved cash flow from operations and the sale of 1.3 million Common Shares in 1993 for net proceeds of $62 million. In spite of the increase in sales in 1993 to record levels, heightened emphasis on efficient asset management is reflected in the $21 million decline in inventories to $434 million at December 31, 1993. An increase in accounts receivable resulting from improved 1993 sales was more than offset by a reduction due to the collection of receivables at AIL as a consequence of the definitization of contract modifications as agreed to with the United States Air Force late in 1992; the net impact of the increase and offsetting decrease resulted in a $78 million decline in accounts receivable to $550 million at December 31, 1993. In addition, accounts receivable days sales outstanding at December 31, 1993 was 43, historically one of the lowest levels, in spite of the expanding economy and sales growth.\nLong-term debt declined to $649 million at year-end 1993 from $833 million at the end of 1992 primarily due to the call for redemption of $74 million of 9% debentures in March 1993 and $89 million of 8.5% debentures in December 1993.\nIn private placements the Company sold 1.3 million Common Shares in 1993 for aggregate net proceeds of $62 million and, in January 1994, an additional 800,000 Common Shares for $38 million. Beginning in April 1995, the holder of these shares has the right to require the Company to register their public sales under the Federal securities law.\nCapital expenditures were $227 million, one of the Company's highest levels, in 1993 compared with $186 million in 1992, as the Company maintained its emphasis on enhancing manufacturing efficiencies and capabilities. Capital expenditures in 1994 are anticipated to be higher than 1993 for those businesses unrelated to the acquisition of DCBU. Further capital expenditures are planned relative to the combining of DCBU and ICPDO. During 1993, the Company invested $14 million in small businesses, primarily to establish a joint venture, which will round out product lines and open avenues for market expansion.\nNet cash provided by operating activities increased to $435 million for 1993 from $381 million for 1992. This increase resulted primarily from improved net income, reflecting higher sales and rigorous cost controls. Changes in operating assets and liabilities also contributed to the increase in net cash provided by operating activities in 1993. Operating cash flow and proceeds from the sale of Common Shares during 1993 were more than adequate to fund capital expenditures, cash dividends, the investment in certain small businesses and other corporate purposes.\nOn May 25, 1993, the Company redeemed its share purchase rights at a redemption price of 3-1/3 cents for each right for a total payment of $2 million.\nAt the end of 1993, as a result of the trend of declining long-term interest rates, the discount rate used to measure the projected benefit obligation for pensions was reduced to 7.25% from 8.25%. This change had the effect of increasing the accumulated pension benefit obligation by $103 million with an offsetting decrease in the unamortized net gain. In addition, the rates used to measure the projected benefit obligation for postretirement benefits other than pensions were changed. The changes in rates included a reduction in the discount rate to 7.25% from 8.5%, and in the annual rate of increase in per capita cost of covered health care benefits. These rate changes had the effect of increasing the accumulated postretirement benefit obligation by $49 million with an offsetting increase in the unamortized net loss. The effect on future expense for pensions and postretirement benefits other than pensions will be immaterial.\nAt December 31, 1993 and 1992, the Company had net deferred income tax assets included in current and long-term assets. Management believes it is more likely than not that these tax benefits will be realized through the reduction of future taxable income. Significant factors considered by management in its determination of the probability of the realization of the deferred tax assets include the historical operating results of the Company, expectations of future earnings and the extended period of time over which the postretirement health care liability will be paid.\nOn January 31, 1994, the Company acquired DCBU from Westinghouse Electric Corporation and issued $930 million of short-term commercial paper to finance the acquisition. The Company plans to reduce these short-term financings by the middle of 1994 through expanded use of equity and long-term debt financings. The timing and mix of these financings will depend on market conditions. Of these short-term financings, $555 million will be classified as long-term debt because the Company intends, and has\nthe ability under a new five-year $555 million revolving credit agreement entered into in January 1994, to refinance this debt on a long-term basis. Also, in January 1994, the Company entered into a $555 million 364-day revolving credit agreement. Strong cash flow, reinforced by the projected results of the newly created Cutler-Hammer business unit, should permit the repayment of the financings within the next five years. The Company is maintaining the strength of its balance sheet, and two major debt-rating agencies, Standard and Poor's and Moody's, have confirmed the \"A\" rating on its long-term debt.\nThe Company expects that the economic and market growth experienced in North America during 1993 will continue to expand to additional markets in 1994; however, that growth will likely be moderated by lingering weakness in Europe. Long-range plans continue to be focused on enhancements in quality, productivity and growth in all its major markets. The acquisition of DCBU and integration with ICPDO should create permanent value by streamlining product lines, manufacturing capacity and organization structure and will enable the businesses to realize the synergies resulting from complementary product offerings, operations and technical expertise. This acquisition will reinforce the goal of improving the balance in sales and earnings between the historically strong Vehicle Components segment and the Electrical and Electronic Controls segment. Investments in the form of research and development, marketing and manufacturing programs continue in all key product lines, and plans are to continue to make niche acquisitions which will promote the Company's position in worldwide markets. The Company believes capital resources available in the form of working capital on hand, lines of credit and funds provided by operations will more than adequately meet anticipated capital requirements for capital expenditures and business expansion through niche acquisitions. The acquisition of DCBU required the additional capital resources discussed above.\nThe operations of the Company involve the use, disposal and cleanup of certain substances regulated under environmental protection laws, as further discussed under \"Protection of the Environment\" in the Financial Review. Subject to the difficulty in estimating future environmental costs, the Company expects that any sum it may have to pay in connection with environmental matters in excess of the amounts recorded or disclosed will not have a material adverse effect on its financial condition or results of operations.\nRESULTS OF OPERATIONS - --------------------- 1992 COMPARED TO 1991 - --------------------- Net Sales - --------- Net sales for 1992 were $4.10 billion, up 12% from $3.66 billion in 1991. Certain markets in North America experienced a modest recovery in 1992. However, economies in Europe, Japan and South America continued to weaken, affecting businesses in those areas, and offsetting some strength in North America.\nThe Vehicle Components segment net sales increased to $2.09 billion for 1992, 16% higher than sales of $1.81 billion recorded for 1991. North American sales of heavy and light trucks, vans and sport utility vehicles were strong throughout the year. A marked increase in heavy truck production in North America during the second half of 1992 had a significant favorable impact on this segment's results. Heavy truck production increased 30% in 1992 over prior year levels. Strategic investments also contributed to sales growth through expansion of business into new products and territories. Sales of passenger car and off-highway vehicle equipment slowed in the last half of the year, after showing increases during the first half. Overseas vehicle markets, primarily in Europe, were depressed, and weakened further in the fourth quarter.\nThe Electrical and Electronic Controls segment had net sales of $1.78 billion for 1992, rising 13% from sales of $1.58 billion in 1991. This increase reflects the acquisition of Kirsten, a European automotive controls manufacturer with 1992 sales of approximately $120 million, and other smaller acquisitions during 1992 and 1991. Existing automotive and appliance controls businesses experienced a strong rebound in their markets, adding to the improved results. Sales from industrial and commercial controls businesses were flat, with the recovery in residential markets offset by continued contraction in military and commercial aircraft industries. Sales from specialty controls businesses declined slightly, reflecting the continued weakening of the North American automated materials handling market, as well as significant softening of the semiconductor equipment markets in the United States and Japan.\nOperating Results - ----------------- Higher sales levels, benefits of recent restructurings and rigorous inventory controls produced an improved gross margin of $967 million in 1992 (24% of sales), up from $851 million in 1991 (23% of sales). Gross margin in 1992 was reduced by $17 million of increased expense related to the accounting change for postretirement benefits other than pensions.\nSelling and administrative expenses were held level relative to sales due to stringent cost controls, as well as the benefits of recent restructurings, with $578 million reported in 1992 compared to $520 million in 1991 (14% of sales in both years).\nThe Company's continued commitment to improvement of established product lines, and to product innovation and development in markets offering the greatest potential for growth was reflected in the increase in research and development expenses to $151 million in 1992 from $138 million in 1991.\nThe Vehicle Components segment operating profit showed a substantial increase to $170 million for 1992 over profit of $63 million in 1991. Profit for 1992 was reduced by $14 million due to recognition of additional expenses for postretirement benefits other than pensions. The improved profit was largely a result of increased demand for heavy and light trucks, vans and sport utility vehicles previously described and, additionally, benefitted from recent restructurings, for which a $22 million charge was recorded in 1991. Strict cost containment also contributed to growth in profit. Strategic investments in marketing, research and development, and manufacturing improvements should further promote sustainable growth and increases in profit as markets served by this segment strengthen.\nThe Electrical and Electronic Controls segment operating profit was $85 million in 1992 compared to $88 million in 1991. Profit for this segment for 1992 was reduced by $11 million due to recognition of additional expenses related to the accounting change for postretirement benefits other than pensions. Profit for 1991 was reduced by a $17 million restructuring charge recorded in the first quarter. Start-up costs for integration of Kirsten and other acquisitions depressed 1992 profits, but these investments should provide opportunities for growth and profit improvement in the future. The acquisition of Kirsten, a European automotive controls manufacturer with operations in Germany, France and Spain, is a good example of the Company's investment in growth businesses through acquisitions. Restructuring costs due to downsizing of military-related operations reduced profits. In addition, profits for 1992 were affected by depressed sales in certain businesses, as discussed above, the costs of long-range programs in marketing, research and development, and manufacturing improvement, and cost/price pressures.\nOther income--net rose to $23 million for 1992 from $18 million for 1991, primarily due to an $11 million pretax gain on the sale of the Company's interest in a limited partnership recorded in 1992.\nAn analysis of changes in income taxes and the effective income tax rate is presented under \"Income Taxes\" in the Financial Review.\nEaton Corporation 1993 Annual Report on Form 10-K Item 14(c) Listing of Exhibits Filed\n3 Amended Articles of Incorporation (as amended and restated as of January 24, 1989, filed on Form SE on March 13, 1989) and Amended Regulations (as amended and restated as of April 27, 1988, filed on Form SE on March 13, 1989)\n4(a) Instruments defining rights of security holders, including indentures (Pursuant to Regulation S-K Item 601(b)(4), the Company agrees to furnish to the Commission, upon request, a copy of the instruments defining the rights of holders of long-term debt of the Company and its subsidiaries)\n10 Material contracts\n(1) DCBU Purchase Agreement dated as of August 10, 1993 between Westinghouse Electric Corporation (Seller) and Eaton Corporation (Buyer) Regarding the Distribution and Control Business Unit of Westinghouse Electric Corporation (Agreement) - Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993\nIncluding the following Exhibits to the Agreement: (i) Form of Technology Agreement (Ex. 2.1) (ii) Terms of Lease for Shared Facilities (Ex.9.6(a) (1)) (iii) Terms of Sublease for Shared Facilities (Ex. 9.6(a) (2)) (iv) Terms of Lease for Vidalia, Georgia Shared Facility (Ex. 9.6(b) (1) (i)) (v) Terms of Lease by Buyer of Part of Horseheads Facility (Ex. 9.6(b) (1) (ii)) (vi) Terms for Jackson, Mississippi Sublease (Ex. 9.6(b) (2)) (vii) Form of Services Agreement (Ex. 9.8) (viii) Form of WESCO Distributor Agreement (Ex. 9.9) (ix) Form of Interim NEWCO Distributor Agreement (Ex. 7.15.2) (x) Form of NEWCO Distributor Agreement (xi) Form of Supplier and Vendor Agreement (Ex. 9.10)\n(2) The following are either a management contract or a compensatory plan or arrangement:\n(a) Deferred Incentive Compensation Plan (as amended and restated May 1, 1990; filed as a separate section of this report)\n(b) Executive Strategic Incentive Plan, effective as of January 1, 1991 - Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992\n(c) Group Replacement Insurance Plan (GRIP), effective as of June 1, 1992 - Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1992\n(d) 1991 Stock Option Plan - Incorporated herein by reference to the Company's definitive proxy statement dated March 18, 1991\n(e) The following are incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990:\n(i) Strategic Incentive and Option Plan (as amended and restated as of January 1, 1989)\n(ii) Limited Eaton Service Supplemental Retirement Income Plan (as amended and restated as of January 1, 1989)\n(iii) Amendments to the 1980 and 1986 Stock Option Plans\n(iv) Form of \"Change in Control\" Agreement entered into with all officers of Eaton Corporation\n(v) Eaton Corporation Supplemental Benefits Plan (as amended and restated as of January 1, 1989) (which provides supplemental retirement benefits)\n(vi) Eaton Corporation Excess Benefits Plan (as amended and restated as of January 1, 1989) (with respect to Section 415 limitations of the Internal Revenue Code)\n(f) The following are incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended December 31, 1990 (filed on Form SE dated March 28, 1991):\n(i) Executive Incentive Compensation Plan\n(ii) Plan for the Deferred Payment of Directors' Fees (as amended and restated as of January 1, 1989)\n(iii) Plan for the Deferred Payment of Directors' Fees (originally adopted in 1980 and amended and restated in 1989)\n(iv) Eaton Corporation Retirement Plan for Non-Employee Directors (as amended and restated as of January 1, 1989)\n11 Statement regarding computations of net income per Common Share (filed as a separate section of this report)\n21 Subsidiaries of Eaton Corporation (filed as a separate section of this report)\n23 Consent of Independent Auditors (filed as a separate section of this report)\n24 Power of Attorney (filed as a separate section of this report)"},"word_count":{"kind":"number","value":13622,"string":"13,622"},"character_count":{"kind":"number","value":89355,"string":"89,355"}}},{"rowIdx":285,"cells":{"filename":{"kind":"string","value":"799036_1993.txt"},"id":{"kind":"string","value":"799036_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"799036"},"text":{"kind":"string","value":"Item 1. Business\nGENERAL\nThe Company, through its subsidiaries, provides health and life insurance underwriting, marketing and managed healthcare services throughout the nation.\nIn 1993 the Company was organized into three Business Divisions: Insurance (Life & Health Units), Marketing and Managed Care. The Divisions were designed to allow management to focus on the specific needs, problems, customers and opportunities in each business area.\nThe Health Unit of the Insurance Division underwrites small group and individual major hospital and medical policies, Medicare supplement, home health care and other specialty products. Medicare supplement insurance, which the Company began offering in 1966 at the inception of the federal Medicare program, accounted for approximately 33% of the Company's health insurance premiums written in 1993. Major hospital insurance plans designed for small business owners and self-employed individuals accounted for approximately 59% of the Company's health insurance premiums written in 1993.\nThe Life Unit underwrites term life, interest sensitive life, universal life, and annuities. In 1990 the Company acquired Manhattan National Life Insurance Company, which has now become the Company's major life and annuity subsidiary. Manhattan National Life's products are distributed primarily through 8,000 brokers throughout the nation. In 1992 all life and annuity administration was consolidated at this subsidiary to enhance efficiency and service.\nThe Marketing Division provides insurance and non-insurance marketing services for insurance companies, associations and financial institutions. The Division operates through four distribution channels: a nationwide network of approximately 1,500 career agents market insurance products to self-employed individuals and small business owners. Senior insurance products are marketed through nearly 15,000 independent agents. A network of 8,000 brokers sells life and annuity products. In 1993 the Company acquired Continental Marketing Corp. which provided a telemarketing system marketing products directly to 8,000 brokers throughout the nation. The Marketing Division markets the Company's insurance products as well as insurance products of other unaffiliated companies. This allows the Company to derive revenue in territories where it is not licensed and to distribute policies not otherwise offered by the Company.\nThe Marketing Division also includes a non-insurance unit which primarily designs benefit packages and provides membership management services to associations across the nation. This unit also provides an emergency air ambulance service for members of associations it manages.\nThe Managed Care Division provides healthcare coordination to control medical expense costs for insurance companies, government agencies, self- insured businesses, unions, HMO's and third-party administrators. Services include pre certification of care, provider networks and case management. In early 1990 the Company acquired National Health Services, Inc. to provide these types of services for its own subsidiaries as well as unaffiliated companies and organizations. In 1993 the Company acquired Healthcare Review Corporation which provides service primarily to government agencies.\nThe Company was organized in Delaware in 1982 as a successor to an Illinois holding company formed in 1957. The Company's largest operating insurance subsidiary is Pioneer Life Insurance Company of Illinois (Pioneer Life), a successor to a company organized in 1926. Health and Life Insurance Company of America, National Group Life Insurance Company, Manhattan National Life Insurance Company and Continental Life & Accident Company were acquired in 1985, 1986, 1990 and 1993, respectively, primarily for specialized marketing purposes.\nIn 1993 the Company relocated its corporate offices from Rockford, Illinois to Schaumburg, Illinois. The executive offices of the Company are now located at 1750 East Golf Road, Schaumburg, Illinois 60173 and its telephone number is (708) 995-0400. The term \"Company\" refers to Pioneer Financial Services, Inc. (PFS) and, unless the context otherwise requires, its subsidiaries.\nInformation on revenue and income by Business Division is set forth in Note 19 of the Notes to Consolidated Financial Statements.\nPRODUCTS\nHealth Insurance Unit\nThe Company's accident and health insurance products, all of which are individually underwritten and issued, include Medicare supplement insurance, major hospital insurance plans, medical/hospital supplement insurance, long term care, home health care and various specialty health coverages. Medicare supplement insurance provides coverage for certain hospital and other medical costs not covered by the Medicare program. Major hospital insurance plans, which are offered on a group trust and association basis as well as on an individual basis, provide coverage for specified hospital costs. Medical/hospital supplemental policies provide coverage for hospital, medical and surgical costs within various prescribed policy deductible and benefit limits. Long term care policies provide coverage for nursing home expenses and other extended care situations. Home health care policies provide coverage for extended in-home medical care. The Company's specialty health products include supplemental medical/surgical plans. Product development efforts have generated new versions of these products as market needs have changed.\nThe Company may adjust premium rates by class, policy form and state in which the policy is issued in order to maintain anticipated loss ratios.\nSince premium rate adjustments can have the tendency to increase policy lapses, conservation and customer service activities are emphasized. As a result, the Company successfully avoided any significant increases in policy lapses in either the small business or senior divisions.\nThe Health Insurance unit also has a distinct department to focus solely on premium rate adjustments. This proactive approach involves strict scrutiny of all health premium rates on a monthly basis. The matching of pricing structure with actual claims experience varies by product line and state. This ongoing analysis provides the time basis necessary for orderly adjustment of premiums.\nThe Company's loss ratios have varied over the years reflecting changes in medical claim costs and the frequency of benefit utilization by its insureds. The following table sets forth the earned premiums, losses and loss adjustment expenses incurred and loss ratios for the Company's accident and health business. Earned premiums reflect written premiums adjusted for reinsurance and changes in unearned premiums. In the Company's statement of consolidated operations, premiums represent premiums written, adjusted for reinsurance; the changes in unearned premiums are reflected in benefits, together with losses and loss adjustment expenses. Losses and loss adjustment expenses include losses incurred on insurance policies and the expenses of settling insurance claims, including legal and other related fees and expenses.\nYear Ended December 31, 1993 1992 1991 1990 1989 (Dollars in thousands) Medicare Supplement Earned premiums . . . . . $199,333 $211,756 $233,033 $197,771$146,707 Losses and loss adjustment expenses . . . . . . . 126,300 143,181 159,423 136,093 93,809 Loss ratio . . . . . . . 63% 68% 68% 69% 64% Medical/Hospital Supplement Earned premiums . . . . . $ 9,410 $11,706 $ 15,725 $ 9,281$ 6,796 Losses and loss adjustment expenses . . . . . . . 7,140 9,865 12,757 6,025 4,361 Loss ratio . . . . . . . 76% 84% 81% 65% 64% Major Hospital Earned premiums . . . . . $375,275 $302,881 $294,431 $234,004$124,744 Losses and loss adjustment expenses . . . . . . . 251,955 200,781 176,222 168,939 61,951 Loss ratio . . . . . . . 67% 66% 60% 72% 50% Specialty Health Earned premiums . . . . . $34,739 $41,235 $ 49,895 $ 42,357$ 30,747 Losses and loss adjustment expenses . . . . . . . 21,121 23,103 28,266 31,189 14,088 Loss ratio . . . . . . . 61% 56% 57% 74% 46% Total Accident and Health Earned premiums . . . . . $618,757 $567,578 $593,084 $483,413$308,994 Losses and loss adjustment expenses . . . . . . . $406,516 $376,930 376,668 342,246 174,209 Loss ratio . . . . . . . 66% 66% 64% 71% 56%\nMedicare Supplement. Since the inception of the Medicare program in 1966, the Company has offered policies designed to supplement Medicare benefits. Such policies accounted for approximately 39% of health insurance premiums in 1991, approximately 37% of health premiums in 1992, and approximately 33% of health premiums in 1993. These policies provide payment for deductibles and the excess over maximum limits of the federal Medicare program. Under these policies, annual premiums are increased if policy benefits increase as a result of changes in Medicare coverage. In 1991 the National Association of Insurance Commissioners (NAIC) defined 10 model Medicare supplement policies. In states which have adopted the NAIC model, only those 10 policies can be sold. In anticipation of state actions, the Company in 1991 developed 8 of the 10 model policies -- those which the Company believes are most applicable to the Company's market. This regulation, along with mandated changes to agent commissions, resulted in marketing changes. By July 1992 all states were required to have adopted the NAIC model or similar legislation which specifically defines policy models. It is not possible to predict the impact which any future Medicare legislation may have on the Company's Medicare supplement business.\nMedical/Hospital Supplement. The Company offers medical/hospital policies which provide limited supplemental benefits for hospital, surgical and medical expenses on either an individual or a family basis. Generally,\nthese policies are automatically renewable at the option of the policyholder, but the Company has the right to adjust premium rates on a class basis. Policy benefits are limited to a specified aggregate amount for all covered expenses. These policies generally provide a fixed benefit for each day of hospitalization, a limited fee schedule for surgical benefits and a limited amount payable for miscellaneous expenses depending upon the length of hospital stay.\nMajor Hospital. The Company offers major hospital insurance plans on an individual basis and on a group trust and association basis and has issued master policies for such plans to several trusts and associations. These plans, which are individually underwritten, are designed to cover in- hospital expenses for small business owners, self employed individuals, employees and their families. Hospital, surgical and other medical expenses are covered on an expense incurred basis with certain benefit limits after a prescribed deductible. Some plans offer a \"reducing deductible\" which provides for the lowering of the deductible if no claims are filed over a number of consecutive years. The Company has more recently introduced new products with benefit alternatives such as increased deductibles and different benefit structures designed to enable policyholders to maintain insurance protection without increased premium rates. In 1991 the Company introduced a new line of products called Design Benefit Plans which provide greater flexibility of benefit structure for policyholders.\nIn December of 1991, the NAIC adopted the Small Employers Availability Act (\"Act\"). This act affects the rating and underwriting methodology that can be applied to insurance coverage sold to small employers, generally categorized as those employing 25 people or less. The Company does not anticipate this Act will have a material impact on its existing business. In response to the Act, the Company has modified its new products for sale in those states adopting the Act.\nSpecialty Health. The Company offers various specialty health products which typically are sold in conjunction with the Company's principal accident and health products. Policies include hospital indemnity, cancer and short-term disability plans, as well as fixed dollar per diem payments for long-term convalescent care. The Company also offers a short-term major medical policy which provides coverage for a limited period of time. This policy is designed for recent school graduates, individuals between jobs, and others with short term needs. The policy does not cover any pre-existing conditions.\nThe Company also offers long term care and home health care products designed principally for senior citizens. Long term care policies generally provide specified per day benefits for nursing home confinements. Home health care policies provide specified per day benefits for medically necessary health services received in the home and may include benefits for adult day care facility services. The Company also offers comprehensive long term care coverages which provide benefits for all levels of nursing home care, home health care and adult day care.\nLife Insurance Unit\nSubstantially all of the Company's life insurance policies and annuities are individually and medically underwritten and issued, other than small accidental death benefit policies, which are not material to the Company.\nThe following table sets forth the breakdown of premiums collected (including receipts not related to policy charges) among traditional life policies, interest-sensitive and universal life policies and annuities for the periods shown:\nYear Ended December 31, 1993 1992 1991\nAmount Percent Amount Percent Amount Percent (Dollars in thousands) Traditional . . . . . $26,353 50 $20,300 45 $17,968 34 Interest-Sensitive & Universal Life. . 16,300 31 18,399 41 20,676 40 Annuities . . . . . . 10,004 19 6,212 14 13,479 26 Total . . . . . . . $52,657 100 $44,911 100 $52,123 100\nFor 1991, premiums collected from the Company's life insurance products were approximately 26% first year and 74% renewal, for 1992 approximately 27% were first year and 73% renewal, and for 1993 premiums collected were approximately 24% first year and 76% renewal. Traditional policy types accounted for 52%, 49% and 59% of the renewal premiums in the years 1991, 1992 and 1993, respectively.\nThe Company's gross life insurance in force was as follows at the dates shown: December 31, 1993 1992 1991 (Dollars in millions)\nTraditional policies . . . . . . $10,320 $ 8,757 $ 7,507 Interest-sensitive and universal life policies . . . . . . . . 1,503 1,582 1,634 Total . . . . . . . . . . $11,823 $10,339 $ 9,141\nInterest-Sensitive and Universal Life. The Company's interest- sensitive and universal life insurance provide whole life insurance with rates of return which are adjusted in relation to prevailing interest rates. The policies permit the Company to change the rate of interest credited to the policy from time to time. The Company offers single premium policies which provide for payment of the entire premium at time of issuance, and also offers multiple premium policies, including universal life. Universal life insurance products credit current interest rates to cash value accumulations, permit adjustments in benefits and premiums at the policyholder's option, and deduct mortality and expense charges monthly. Under other interest-sensitive policies, premiums are flexible,\nallowing the policyholders to vary the frequency and amount of premium payments, but typically death benefit changes may not be made by the policyholders. Some universal life products offer lower premiums for non- smokers in good health. For both universal life and other interest- sensitive policies, surrender charges are deducted from the policyholder's account value, if any. No surrender charges are deducted if death benefits are paid or if the policy remains in force for a specified period.\nTraditional Life. The traditional life insurance sold by the Company has consisted almost entirely of modified premium whole life policies, which provide permanent coverage with payments of higher premiums in early years than in subsequent years. These policies provide for cash values which are relatively insignificant in early years and gradually increase over the life of the policy. Modified premium whole life policies have frequently been sold in conjunction with annuity riders which supplement the accumulated cash values.\nManhattan National Life offers a variety of non-participating individual life insurance policies, including universal, term and traditional whole life products. Manhattan National Life does not offer group life insurance. For a number of years, Manhattan National Life has offered individually underwritten insurance on the lives of persons who, to varying degrees, do not meet the requirements of standard insurability. Higher premiums are charged for these \"impaired\" or \"substandard\" lives and, where the amount of insurance is large or the risk is significant, a portion of the risk is reinsured.\nAnnuities. The Company's single and flexible premium deferred annuities are offered to individuals. An annuity contract generally involves the accumulation of premiums at a compound interest rate until the maturity date, at which time the policyholder can choose one of the various payment options. Options include periodic payments during the annuitant's lifetime or the lifetimes of the annuitant and spouse, with or without a guaranteed minimum period; periodic payments for a fixed period regardless of the survival of the annuitant; or lump sum cash payment of the accumulated value. The Company's annuities typically provide for the crediting of interest at rates set from time to time by the Company.\nMarketing Division\nThe Company's Marketing Division includes two units: insurance and non-insurance.\nInsurance Unit. This unit markets products to self-employed individuals and small employers through a nationwide network of over 1,500 career agents. Products include catastrophic hospital and major medical expense plans, multiple employer trusts, group and individual dental programs, managed care programs and a variety of supplemental products for tax favored (Section 125 and 401(k)) use.\nThe division markets life and annuity products through approximately 8,000 brokers nationwide. In 1993 the Company acquired\nContinental Marketing Corporation, which provided a new distribution system - a telemarketing organization which markets products directly to 8,000 brokers throughout the nation.\nThe Marketing Division also operates its own telemarketing lead generation company for both the self-employed and senior markets.\nAn established independent brokerage network of nearly 15,000 insurance brokers throughout the nation sells health insurance products to senior Americans. Products include Medicare supplement, home health care, long term care, cancer coverage, life and annuities. Some of these products are underwritten by PFS insurance companies; others are underwritten by non-affiliated carriers.\nNon-Insurance Unit. This division designs benefit packages and provides membership management services to associations across the nation. Benefit packages include group discounts on eyewear, pharmaceuticals, hearing aids, travel, legal and other services. Membership services can range from recruitment campaigns to periodic billing and other administrative services. This unit also provides an emergency air ambulance service for the members of associations it manages.\nMarketing Subsidiaries\nDesign Benefit Plans. The Company's group trust and association major hospital plans for small business owners are marketed through Design Benefit Plans, a subsidiary of National Benefit Plans, which contracts with approximately 1,500 agents and managers who operate exclusively on behalf of the organization through approximately 70 regional offices. The marketing organization is responsible for recruiting, training and supervising these agents. Policies issued under these plans are individually underwritten and issued by the Company at its regional service center in the Dallas, Texas metropolitan area. For 1991, 1992 and 1993, marketing efforts to small businesses produced approximately $288,040,000, $297,734,000, and $354,427,000 respectively, of the Company's written premiums, almost all attributable to accident and health products. Through this marketing organization, the Company has recently entered into agreements with several other insurance companies to market certain coverages which are designed to expand its product lines and marketing territories. These products include large group plans (up to 99 lives), disability income, and tax-deferred annuities.\nThe Company has an established telemarketing subsidiary with facilities in Phoenix, Arizona, and Arlington, Texas. Currently, these facilities, together with the Company's direct mail activity, provide approximately 18,000 qualified leads a week to this division.\nThe Senior Brokerage offers products to the senior market. Currently there are approximately 15,000 brokers associated with this unit. Major products include Medicare Supplement, Long Term Care and Home Health Care, as well as life and annuity products specifically designed for seniors.\nContinental Marketing. With the 1993 acquisition of Continental Marketing Corporation (CMC), the Marketing Division added its fourth distribution system. CMC conducts telemarketing at the brokerage-producer level by providing product and market support. In addition to taking on this new distribution system, the Company is expanding the portfolio available to this group of producers.\nManaged Care Division\nThe Managed Care Division of the Company provides health care coordination to control costs for government agencies, self-insured businesses, insurance companies, unions, HMO's and third-party administrators.\nMajor services provided include pre certification of care, utilization review, preferred or exclusive provider networks (PPOs, EPOs, and HMOs), large case management, risk management and occupational medical management.\nThe Managed Care Division generated substantial claims savings for the Company's insurance subsidiaries in 1993. These savings primarily were passed on to policyholders in the form of lower premium rate adjustments.\nIn 1992 the division began to expand its product line, to include additional products which meet the needs of small employers. These occupational medical programs include specific management of worker's compensation cases to lower employer medical costs and return the employee to the workplace more quickly.\nThe division has also continued to expand its PPO (preferred provider organization) network which is available to clients on a fee dependent on savings achieved. By expanding the network, it becomes even more attractive and more marketable to additional companies and organizations.\nA new EPO (exclusive provider organization) was also successfully test marketed late in 1992. The EPO was attached to a major medical insurance policy underwritten by a health insurance subsidiary of the Company. The EPO was used to reduce the insurance premiums on the policy by taking advantage of lower negotiated medical expense rates with the exclusive provider.\nPremium Distribution\nThe Company's insurance subsidiaries collectively are licensed to sell insurance in 49 states and the District of Columbia. The importance to the Company of particular states may vary over time as the composition of its agency network changes. The geographic distribution of collected premiums (before reinsurance) of the Company's subsidiaries in 1993 was as follows:\nTotal Percent (Dollars in thousands)\nFlorida $69,985 10.4\nCalifornia 67,391 10.0 Texas 64,279 9.5 Illinois 51,436 7.6 North Carolina 28,925 4.3 Ohio 22,532 3.3 Georgia 21,619 3.2 Missouri 20,256 3.0 Other (1) 327,752 48.7 Total $674,175 100.0\n(1) Includes 41 other states, the District of Columbia, and certain U.S. territories and foreign countries, each of which account for less than 3% of collected premiums.\nUNDERWRITING\nSubstantially all of the Company's insurance coverages are individually underwritten to assure that policies are issued by the Company's insurance subsidiaries based upon the underwriting standards and practices established by the Company. Applications for insurance are reviewed to determine if any additional information is required to make an underwriting decision, which depends on the amount of insurance applied for and the applicant's age and medical history. Such additional information may include medical examinations, statements from doctors who have treated the applicant in the past and, where indicated, special medical tests. If deemed necessary, the Company uses investigative services to supplement and substantiate information. For certain coverages, the Company may verify information with the applicant by telephone. After reviewing the information collected, the Company either issues the policy as applied for, issues the policy with an extra premium charge due to unfavorable factors, issues the policy excluding benefits for certain conditions for a period of time or rejects the application. For certain of its coverages, the Company has adopted simplified policy issue procedures in which the applicant submits a simple application for coverage typically containing only a few health related questions instead of a complete medical history.\nIn common with other life and health insurance companies, the Company may be exposed to the risk of claims based on AIDS. The Company's AIDS claims to date have been insignificant. Because of its emphasis on policies written for the senior citizen market and its underwriting procedures and selection processes, the Company believes its risk of AIDS claims is less than the risk to the industry in general.\nREINSURANCE\nThe Company's insurance subsidiaries reinsure portions of the coverages provided by their insurance products with other insurance companies on both an excess of loss and co-insurance basis. Co-insurance generally transfers a fixed percentage of the Company's risk on specified coverages to the reinsurer. Excess of loss insurance generally transfers the Company's risk on coverages above a specified retained amount. Under\nits excess of loss reinsurance agreements, the maximum risk retained by the Company on one individual in the case of life insurance is $100,000 ($250,000 in the case of Manhattan National Life) and in the case of accident and health insurance is $250,000.\nReinsurance agreements are intended to limit an insurer's maximum loss on the specified coverages. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured, but it is the practice of insurers (subject to certain limitations of state insurance statutes) to account for risks which have been reinsured with other approved companies, to the extent of the reinsurance, as though they are not risks for which the original insurer is liable. See Note 5 of Notes to Consolidated Financial Statements.\nThe Company has occasionally used assumption reinsurance to acquire blocks of business from other insurers. In addition, the Company has from time to time entered into agreements to assume certain insurance business from companies for which it is marketing insurance products. The Company intends to continue these programs if they assist in expanding product lines and marketing territories.\nINVESTMENTS\nInvestment income represents a significant portion of the Company's total revenues. Insurance company investments are subject to state insurance laws and regulations which limit the types and concentration of investments. The following table provides information on the Company's investments as of the dates indicated.\nDecember 31, 1993 1992\nAmount % Amount % (Dollars in thousands)\nFixed maturities to be held to maturity: U.S. Treasury $ 9,124 1% $ 15,363 3% States and political subdivisions 5,200 1 199 - Corporate securities 119,276 18 98,836 17 Mortgage-backed securities 192,912 29 320,328 56 Total fixed maturities to be held to maturity 326,512 49 434,726 76\nFixed maturities available for sale: U.S. Treasury 26,894 4 1,425 - States and political subdivisions 21,571 3 - - Foreign governments 4,056 1 - - Corporate securities 73,981 11 6,343 2 Mortgage-backed securities 131,215 19 30,983 6 Total fixed maturities available for sale 257,717 38 38,751 8\nEquity securities........... 17,436 3 19,537 3 Mortgage and policy loans... 27,189 4 21,969 4 Short-term investments...... 45,352 6 53,366 9\nTotal Investments...... $674,206 100% $568,349 100%\nAt December 31, 1993, the average expected term of the Company's fixed maturity investments was approximately six years.\nThe results of the investment portfolio for the periods shown were as follows:\nYear Ended December 31, 1993 1992 1991 (Dollars in thousands)\nAverage month-end investments . $592,546 $549,643 $532,336 Net investment income . . . . . 40,242 43,555 47,974 Average annualized yield on investments (1) . . . . . . . 6.8% 7.9% 9.0% Realized investment gains/ (losses) (2) . . . . . . . . . $(1,336) $ (47) $ 7,189\n(1) Not computed on a taxable equivalent basis. Includes interest income paid or accrued on debt securities and loans and dividends on equity securities.\n(2) See Note 3 of Notes to Consolidated Financial Statements for information on unrealized appreciation on investments.\nThe Company's investment policy is to balance its portfolio between long-term and short-term investments so as to achieve investment returns consistent with preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. Current policy is to invest primarily in fixed income securities of the U.S. government and its agencies and authorities, and in fixed income corporate securities with investment grade ratings of Baa or better. At December 31, 1993, less than 1% of the Company's total investment portfolio was below investment grade or unrated. The Company intends to invest no more than 5% of its total invested assets in securities below investment grade.\nAt December 31, 1993, approximately 2% of the Company's total investment portfolio were mortgage-backed derivative securities. The significant decline in interest rates during 1992 and 1993 caused the value of these securities to deteriorate. The Company has partially written-down the carrying value of these securities in 1992 and 1993. This write-down was generally offset by realized gains on the remaining portfolio.\nPOLICY LIABILITIES\nThe Company records reserves for future policy benefits to meet future obligations under outstanding policies. These reserves are amounts which are calculated to be sufficient to meet policy and contract obligations as they mature. The amount of reserves for insurance policies is calculated using assumptions for interest, mortality and morbidity, expenses and withdrawals. Reserves are established at the time the policy is issued and adjusted periodically based on reported and unreported claims or other information. See Note 1 of Notes to Consolidated Financial Statements.\nCOMPETITION\nThe insurance business is highly competitive and includes a large number of insurance companies, many of which have substantially greater financial resources and larger and more experienced staffs than the Company. The Company competes with other insurers to attract and retain the allegiance of its independent agents and marketing organizations who at this time are responsible for most of the Company's premiums. Methods of competing for agents are described under \"Marketing.\" Methods of competition include the Company's ability to offer competitive products and to service these programs efficiently. Other competitive factors applicable to the Company's business include policy benefits, service to policyholders and premium rates.\nHEALTHCARE REFORM\nThe Company expects that a federal healthcare \"reform\" program will be passed by Congress and will be implemented over the remainder of the decade. It is most likely to include most of the following in some form: universal access, minimum mandated benefits, coverage for pre-existing conditions and guaranteed portability.\nThe Company's insurance subsidiaries have already adapted to state small group healthcare reform programs by making the necessary adjustments in our products and marketing structure. The Company also expects to adapt and adjust to a federal reform program in much the same way.\nThe best-case \"reform\" scenario for the Company would be mandated workplace medical coverage--required either of individuals or employers-- while retaining the current free market system and wide choices for consumers. This would increase the market by over 30 million and allow the Company to continue our current distribution system.\nThe worst-case scenario would be the elimination of current indemnity \"fee-for-service\" medical policies for small groups by any but a handful of insurance companies. This oligopoly would eliminate a major health insurance market and revenue source for the Company. As a result, we are now placing a major concentration on growth in supplemental and senior health insurance and life insurance and annuities. These areas are not likely to be adversely impacted by any of the reform programs currently proposed.\nIf federal healthcare reforms are enacted that eliminate indemnity \"fee-for-service\" health plans or limit our ability to adjust premium rates (price controls), there could be a significant impact on our deferred policy acquisition costs (DAC) on our small group major medical business which represents approximately one-third of our DAC asset and is significantly offset by benefit reserves. The larger part of our DAC asset is in our senior health, life and annuity products, which should not be impacted by healthcare reform. With federal healthcare reform, there could be a material increase in the rate of amortization of DAC in the future for our small employer medical insurance. While the Company must consider\nalternative actions for worst case scenarios, we are optimistic that the final compromise reform legislation will not have this type of impact on our business.\nGOVERNMENT REGULATION\nIn common with all domestic insurance companies, the Company's insurance subsidiaries are subject to regulation and supervision in the jurisdictions in which they do business under statutes which typically delegate regulatory, supervisory and administrative powers to state insurance commissions. The method of such regulation varies, but regulation relates generally to the licensing of insurers and their agents, the nature of and limitations on investments, approval of policy forms, reserve requirements, the standards of solvency which must be met and maintained, deposits of securities for the benefit of policyholders, periodic examination of insurers, and trade practices, among other things. The Company's accident and health coverages generally are subject to rate regulation by state insurance commissions which in certain cases require that certain minimum loss ratios be maintained.\nCertain states also have insurance holding company laws which require registration and periodic reporting by insurance companies controlled by other corporations licensed to transact business within their respective jurisdictions. The Company's insurance subsidiaries are subject to such laws and are registered as controlled insurers in those jurisdictions in which such registration is required. Such laws vary from state to state but typically require periodic disclosure concerning the corporation which controls the registered insurers and all subsidiaries of such corporation, and prior notice to, or approval by, the state insurance commission of intercorporate transfers of assets and other transactions (including payments of dividends in excess of specified amounts by the insurance subsidiary) within the holding company system.\nEMPLOYEES\nAs of December 31, 1993, the Company employed approximately 1,900 persons on a full-time basis. The Company considers its employee relations to be good.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the executive officers and directors of the Company is set forth below:\nPeter W. Nauert............... 50 Chairman, Chief Executive Officer, President and Director\nWilliam B. Van Vleet.......... 69 Executive Vice President, General Counsel and Director\nCharles R. Scheper............ 41 Executive Vice President\nAnthony J. Pino............... 46 Executive Vice President\nJoan F. Boyle.................. 46 Senior Vice President\nPhilip J. Fiskow.............. 37 Senior Vice President\nErnest T. Giambra, Jr.......... 46 Senior Vice President\nThomas J. Brophy.............. 58 Senior Vice President\nDavid I. Vickers.............. 33 Treasurer and Chief Financial Officer\nMichael A. Cavataio.......... 49 Director\nRichard R. Haldeman.......... 50 Director\nNolanda S. Hill.............. 48 Director\nKarl-Heinz Klaeser........... 61 Director\nMichael K. Keefe............. 49 Director\nRobert F. Nauert............. 69 Director\nAll executive officers are elected annually and serve at the pleasure of the Board of Directors.\nPeter W. Nauert has been Chief Executive Officer and a director of the Company since its incorporation in 1982. He was President of the Company from 1982 to 1988 and became Chairman of the Company in 1988. On September 1, 1991, he was again elected President. Since 1968, Mr. Nauert has been employed in an executive capacity by one or more of the Company's insurance subsidiaries.\nWilliam B. Van Vleet has been Executive Vice President of the Company since 1986 and a director of the Company since 1982. He was General Counsel of the Company from 1982 to 1988. In June 1991, he was again elected General Counsel. Mr. Van Vleet has served Pioneer Life since 1948 as General Counsel and a Director. Mr. Van Vleet also serves as an Officer and Director of other subsidiaries of the Company.\nCharles R. Scheper has been Vice President of the Company since 1991 and was Chief Financial Officer from May 1993 to December 1993. In March 1992, he was elected Executive Vice President. Since February 14, 1992, he has been President and Vice Chairman of the Board of Manhattan National Life. Prior to the Company's acquisition of Manhattan National Life, Mr. Scheper was Manhattan's Senior Vice President and Chief Financial Officer, a position which he held from May 1987. Prior to joining Manhattan National Life, Mr. Scheper was with Union Central Life from 1979, having served as Vice President and Controller since 1985.\nAnthony J. Pino was elected Executive Vice President of the Company in May 1993. He was Senior Vice President of the Company from March 1992 to May 1993 and was President of National Group Life Insurance Company from July 1991 to June 1992. Mr. Pino has served as President of National Health Services since 1992. Prior to joining the Company, Mr. Pino was Chief Operating Manager of American Postal Workers' Union Health Plan, a position which he held from October 1982.\nJoan F. Boyle has been Senior Vice President since joining the Company in September of 1992. She is also an Officer of other subsidiaries of the Company. Prior to joining the Company, Ms. Boyle was Vice President of Sales of Empire Blue Cross/Blue Shield from October 1991 to August 1992. From 1969 to 1991, she was Executive Vice President and Chief Financial Officer with New Jersey Blue Cross/Blue Shield.\nPhilip J. Fiskow has been Senior Vice President since May 1993 and the Chief Investment Officer since joining the Company in 1991. He was Vice President of the Company from June 1991 until May 1992. He is also an officer of other subsidiaries of the Company. Mr. Fiskow was with Asset Allocation and Management as an Investment Advisory Portfolio Manager from January 1989 to June 1991. From May 1987 to December 1988 he was an Investment Advisor with Van Kampen Merritt and a Portfolio Manager with Aon Corporation from May 1981 to May 1987.\nErnest T. Giambra, Jr. was elected Senior Vice President of the Company in June 1993. Prior to joining the Company, Mr. Giambra had been with Bankers Life Holding Corporation since 1969 where he had served as Vice President of Sales since 1988.\nThomas J. Brophy has been Senior Vice President since joining the Company in November 1993. Prior to joining the Company, Mr. Brophy was President and Chief Operating Officer of Southwestern Life Insurance Company from June 1990 to September 1993. Mr. Brophy also held various senior executive positions with various I.C.H. Corporation subsidiaries from March 1974 to his joining of the Company in November 1993.\nDavid I. Vickers has been with the Company since June 1992 and has been a Vice President of the Company since December 1992, Treasurer since May 1993 and Chief Financial Officer since January 1994. He is also an Officer and Director of several subsidiaries of the Company. Prior to joining the Company he was with the public accounting firm of Ernst & Young since 1983 where he was a Senior Manager in the Insurance Division. Mr. Vickers also serves as Treasurer for certain of the Company's insurance subsidiaries.\nMichael A. Cavataio has been a Director of the Company since 1986. Mr. Cavataio has also been President of Lillians, a chain of retail clothing stores, since 1980.\nRichard R. Haldeman has been a Director of the Company since 1986 and was Secretary from 1988 to June 1990. Mr. Haldeman has been a partner of Haldeman & Associates, a law firm, since June 1990. He was a partner of\nWilliams & McCarthy, P.C., a law firm, from 1975 to May 1990.\nNolanda S. Hill has been a Director of the Company since May 1992. Ms. Hill has been Chairman and Chief Executive Officer of Corridor Broadcasting Corporation since 1984. From 1976 to 1984, Ms. Hill served as Chief Executive Officer and Chief Financial Officer of National Business Network, a television station.\nKarl-Heinz Klaeser has been a Director of the Company since 1986. Mr. Klaeser has also been a Director of LSW Holding Corporation and Insurance Investors Life Insurance Company and the Chairman of the Board of Life Insurance Company of the Southwest since 1989 and a Director of Personal Assurance Company PLC (United Kingdom) since 1991.\nMichael K. Keefe has been a Director of the Company since March 1994. Mr. Keefe has been Chief Executive Officer and Chairman of the Board of Keefe Real Estate, Inc., a family owned real estate brokerage operation since 1982. Mr. Keefe has also been Chairman of the Board of Southern Wisconsin Bankshares, Inc. since 1988.\nRobert F. Nauert has been a Director of the Company since November 1991. Mr. Nauert has also been a Director and President of Pioneer Life since 1988 and is a Director and Officer of various subsidiaries of the Company. Mr. Nauert is the brother of Peter W. Nauert.\nItem 2.\n\n\nItem 2. Properties\nThe principal executive offices of the Company are located in Schaumburg, Illinois in a building purchased by the Company in January 1994. The Company, through a subsidiary, owns three buildings in Rockford, Illinois. The Company believes these facilities will adequately serve its needs for the foreseeable future and could accommodate expansion of the Company's business. The Company, through another subsidiary, also owns a building in the Dallas, Texas metropolitan area which currently serves as the main administrative office for the Company's small business market of the Health Insurance unit. The Company leases the office of its other regional service centers. The executive and administrative offices of Manhattan National Life are located in Cincinnati, Ohio in leased space.\nItem 3.\nItem 3. Legal Proceedings\nThe Company and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. The Company's management and its legal counsel are of the opinion that the disposition of these actions will not have a material adverse effect on the Company's financial position.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders\nNONE\nPART II\nItem 5.\nItem 5. Market for Registrant's Common Equity and Related Stockholders Matters\nThe Company's Common Stock is traded on the New York Stock Exchange and Chicago Stock Exchange. The following table sets forth, for the periods indicated, the high and low last reported sale prices for the Common Stock on the New York Stock Exchange as reported on the consolidated transaction reporting system.\nHigh Low Quarter ended:\nMarch 31, 1992.............. 9 1/8 6 1/4 June 30, 1992............... 8 5/8 6 1/4 September 30, 1992.......... 6 3/4 4 7/8 December 31, 1992........... 6 4\nMarch 31, 1993.............. 5 1/2 4 3/4 June 30, 1993............... 9 1/8 5 1/4 September 30, 1993.......... 10 7/8 8 3/8 December 31, 1993........... 14 10 1/2\nAs of December 31, 1993, there were approximately 600 holders of record of the Company's Common Stock.\nOn March 18, 1994, the PFS Board of Directors announced a quarterly common stock dividend of 3.75 cents per share with an expectation of a total of 15 cents per share to be paid for 1994.\nItem 6.\nItem 6. Selected Consolidated Financial Data\nThe following selected consolidated financial data for the five years ended December 31, 1993; are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein. The comparability of the results for the periods presented is affected by certain transactions as described in Note 18 of Notes to the Consolidated Financial Statements.\nItem 7.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nRESULTS OF OPERATIONS\n1993 Compared to 1992\nDivision Overview\nThe income (loss) before income taxes by Division for 1993 and 1992 are as follows (in thousands):\n1993 1992 Insurance: Health Unit $ 8,578 $(26,613) Life Unit 7,623 340 Marketing 10,205 3,345 Managed Care (1,211) 335 Corporate (6,431) (2,843) Total $18,764 $(25,436)\nHealth\nThe significant increase in pre tax income for 1993 is due principally to the $30 million pre tax write-down of deferred policy acquisition costs in 1992. The remaining increase is due to the improved loss ratios on the Medicare supplement business and stabilized loss ratios on major hospital products. The improved loss ratios on Medicare supplement (63.4% in 1993 versus 67.6% in 1992) allowed the Company to freeze 1994 premiums for certain of these products in many states. The Company has received positive customer response to this action and expects that will increase retention on this business. Cost reduction programs have reduced the general insurance expense ratios (excludes commissions) down to 9.8% in\n1993 from 10.2% in 1992 despite one-time consolidation costs of certain operations.\nLife\nThe consolidation of all life insurance administration to one location on December 31, 1992, contributed to reduced general expenses in 1993 and the resulting increase in pre tax income. The unit cost per policy in- force decreased from $150 in 1992 to approximately $80 in 1993. In addition, interest spreads on life and annuity business improved despite the decline in investment yields in 1993. The mortality on the existing block of life business continued to improve in 1993 from the levels experienced in 1992. The Company is placing more emphasis on increasing life and annuity business during the next five years to mitigate any adverse effects due to healthcare reform.\nMarketing\nThe increase in pre tax income was due to a 14% increase in revenue over a relatively fixed expense base. The division continued to lower lead generation costs and development costs associated with a new commission payment system during 1993. The 1992 results were negatively affected by approximately $2 million due to the settlement of certain disputes with former agents. The Marketing Division currently receives the commission overrides previously due these agents pursuant to the settlement.\nManaged Care\nThe division experienced a pre tax loss of $1.2 million primarily due to start-up costs associated with a new third-party administrator and occupational medical management company formed in 1993, as well as costs of a complete rewrite of the medical criteria. The division discontinued the operation of the third-party administrator in the fourth quarter of 1993. The core business of the division increased over 100% during 1993. The significant increase in revenue was offset by sales development costs and personnel additions to support a foundation for future growth.\nCorporate\nInterest expense increased from $2,189,000 in 1992 to $3,276,000 in 1993 due to the issuance of convertible debentures. Corporate expenses also increased due to costs associated with new investor relations programs, expenses related to the public offering, and reallocation of certain senior management personnel who monitor and control division profitability at the corporate level.\nConsolidated Financial Condition and Results of Operations\nThe Company reported net income of $12,145,000 for the twelve months ended December 31, 1993, compared to a net loss of $16,959,000 for the comparable period in 1992. The net loss for 1992 was primarily attributable to a $30,000,000 pre-tax write-down of deferred policy\nacquisition costs. The remaining increase was due to improved loss ratios on the Medicare supplement business, expense reductions in the Life Insurance Unit and increased revenue and margins in the Marketing Division.\nTotal revenues increased $47,751,000 or 7% for the twelve month period in 1993 as compared to 1992. The increase in revenue is due to the increase in premiums and policy charges of $50,449,000 which was partially offset by reduced levels of net investment income.\nAccident and health insurance premiums increased $41,790,000, or 7%, in 1993 as compared to 1992. Premiums from major hospital plans increased $56,694,000 in 1993 as compared to 1992 due to rate increases implemented in 1993, and approximately $11,000,000 from the acquisition of Continental Life & Accident Company. Offsetting the increase was a decline in Medicare supplement premiums of $9,176,000 due to lower than anticipated new sales and a $3,496,000 decrease in premiums of specialty health care plans. Life and annuity premiums and policy charges increased $8,659,000 due to an increase in new life sales during 1993.\nNet investment income decreased $3,313,000 or 8% in 1993 compared to 1992. Annualized investment yields decreased from 7.9% in 1992 to 6.8% in 1993. The decrease in investment yield was due to the general decline in current interest rates and a higher quality portfolio with a shortened duration.\nOther income and realized investment gains and losses increased $615,000, or 4% in 1993 as compared to 1992. Other income increased $1,904,000 in 1993 due to increased sales to unaffiliated customers in both the Marketing and Managed Care Divisions. Realized investment losses increased $1,289,000 due to write-downs on certain mortgage-backed derivative securities. As disclosed in Note 3 to the Consolidated Financial Statements, the Company has established an allowance for losses on investments held in the amount of $4,200,000, which the Company believes is adequate to provide for other-than-temporary market declines.\nTotal benefits increased $26,310,000 or 6% in 1993 as compared to 1992. Life and annuity benefits decreased $3,607,000 or 8% due to the general decline in credited rates during 1993 and improved mortality over the higher levels experienced during 1992. Accident and health benefits, which includes the change in unearned premiums, increased $29,917,000 or 8% in 1993 as compared to 1992. The change was primarily due to the 7% increase in accident and health premiums. The Company's accident and health loss ratios were unchanged over 1992 at 66%. The improved loss ratios on the Medicare supplement business were offset by the fourth quarter loss ratio on Continental Life & Accident business of 79%. The Company is attempting to control claim costs on this block of business by implementing additional managed healthcare efforts.\nIn 1993 and 1992, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $41 million and $27 million, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes\ngenerally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:\n1993* 1992* 1991* PPOs (preferred provider organization) networks 49% 64% 72% Precertification 5 17 16 Large case management 32 11 2 Other 14 8 10 100% 100% 100%\n* Percent of total estimated savings from managed healthcare efforts.\nThe Company expects to continue to emphasize managed care procedures to control claim costs. Although the Company cannot accurately determine the amount savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of growth in cost savings due to the efficiencies that have already been achieved.\nAmortization of deferred policy acquisition costs (DAC) decreased $23,840,000, or 24%, in 1993 as compared to 1992. The decrease was due to the $30 million pre tax write-down of DAC in the fourth quarter of 1992 primarily on major medical policies sold in the self-employed and small business owner market. The 1993 amortization rate on Medicare supplement is higher than 1992 because of the accelerated rate increase implementation which occurred in 1993. As discussed previously, the Company expects the Medicare supplement persistency to improve in 1994 with the modest rate action required. The Company continues to monitor persistency closely since future rate increases and regulatory reforms could adversly impact lapses in the future. Increased lapses resulting in an increase in the amortization rate of DAC could adversely impact future earnings.\nThe Company's effective tax rate was approximately 35% in 1993. The Company recorded a tax benefit for 1992 due to the operating loss incurred. The effective federal income tax rate increased in 1993 due to the Revenue Reconciliation Act of 1993.\nEffective January 1, 1993 the Company adopted Financial Accounting Standards Board (FASB) Statement No. 113 \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" FASB Statement No. 113 requires that reinsurance receivables, including amounts related to claims incurred but not reported, and prepaid insurance premiums, be reported as assets as opposed to reductions in the related liabilities. As a result of the adoption of FASB Statement No. 113, amounts on deposit and due from reinsurers and policy liabilities each increased $19,453,000 at December 31, 1993.\nEffective January 1, 1993, the Company also changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109 \"Accounting For Income Taxes.\" The cumulative effect of adopting FASB Statement No. 109 was not\nsignificant.\nPresident Clinton presented his health care reform policy in September of 1993. Numerous proposals have been introduced to Congress and the state legislatures to reform the current healthcare system. Proposals have included, among other things, modifications to the existing employer-based insurance system, a quasi-regulated system of \"managed competition\" among health plans and a single payer, public program which would replace some of the Company's current major hospital products. Changes in healthcare policy could significantly affect the Company's Health Unit. The Company is unable to accurately predict what effects these reforms may have on its future operations and is unable to evaluate what impact the expectations of such reforms may have had on past consumer behavior. The Company expects the final package approved by Congress will differ significantly from the program presented by President Clinton. (See Healthcare Reform Section)\nInvestments, equipment, policy liabilities, and general expenses and other liabilities increased due to the acquisition of Continental Life & Accident. Other assets increased primarily due to expenses capitalized in conjunction with the public offering of the convertible subordinated debentures.\nRESULTS OF OPERATIONS\n1992 Compared to 1991\nThe Company reported a net loss of $16,959,000 for the twelve months ended December 31, 1992, compared to net income of $8,872,000 for the comparable period in 1991. The net loss for 1992 was primarily attributable to a $30,000,000 write-down of deferred policy acquisition costs. The remaining decrease was primarily due to reduced levels of new production of senior health insurance, the continued impact of medical inflation, increased utilization of medical services in the health insurance small business market, and lower other income and realized investment gains.\nTotal revenues decreased $52,649,000 or 7% in 1992 as compared to 1991. The decrease was primarily due to reduced writings of accident and health insurance policies principally in the senior market and lower other income and realized gains.\nTotal premiums and policy charges decreased $31,444,000, or 5%, in 1992 as compared to 1991. During 1992 and 1991, in an effort to control the volume and quality of the business produced, the Company reduced the number of brokers and agents selling its products and restructured certain of its agency relationships. These changes resulted in reduced levels of new business being written.\nAccident and health insurance premiums decreased $33,342,000, or 6%, in 1992 as compared to 1991. Premiums from the Company's Medicare supplement plans decreased approximately $35,203,000. In addition, $7,135,000 of the decrease was attributable to a decrease in premium in\nspecialty health care plans. Somewhat offsetting the decrease were premiums from major hospital plans which increased $9,694,000 in 1992 as compared to 1991. Life and annuity premium and policy charges were relatively unchanged for the twelve month period in 1992 as compared to 1991.\nNet investment income decreased $4,303,000, or 9%, in 1992 compared to 1991. Annualized investment yields decreased from 9.0% in 1991 to 7.9% in 1992. The decrease in net investment income was primarily due to the general decline in interest rates, and also the sale of a subsidiary, Union Benefit Life Insurance Company on September 1, 1991.\nOther income and realized investment gains and losses decreased $16,902,000, or 49%, in 1992 as compared to 1991. Other income decreased $8,957,000 in 1992 as compared to 1991. The decrease is principally due to reduced revenues from the Company's non-insurance marketing subsidiaries. The Company's Marketing Division experienced a $6,287,000, or 32%, decrease in revenues, which reflected the discontinuation of certain agent programs. The Company does not expect further declines in revenue from the discontinuation of these agent programs. The Company's Managed Care Division contributed revenues comparable to those in 1991. Realized investment gains, excluding the sale of a subsidiary, decreased $7,236,000 in 1992 as compared to 1991. This is primarily due to the write-down of $5,700,000 on mortgage-backed derivative securities in 1992. As disclosed in Note 3 to the Consolidated Financial Statements, the Company has established an allowance for losses on investments held in the amount of $1,900,000, which the Company believes is adequate to provide for any other-than-temporary market declines.\nTotal benefits decreased $7,280,000, or 2%, in 1992 as compared to 1991 due to the reduced writings of accident and health insurance policies. Life and annuity benefits were relatively unchanged in 1992 as compared to 1991. Accident and health benefits, which include the increase in unearned premiums, decreased $8,774,000, or 2%, in 1992 as compared to 1991. In 1992 the Company's accident and health loss ratio increased to 66% as compared to 64% in 1991. The increase was due to the continued impact of medical inflation and increased utilization of medical services in the small business market. The Company is attempting to minimize the effect of medical inflation and control claim costs by implementing certain managed healthcare efforts.\nIn 1992 and 1991, managed healthcare efforts resulted in estimated net savings to the Company's Health Insurance Unit of $27 million and $13 million, respectively. These savings were primarily used to lower the amount of premium increases for policyholders, which the Company believes generally has the effect of decreasing lapse rates of these policies. The principal efforts and their approximate relative contributions to these estimated savings were as follows:\n1992* 1991* PPOs (preferred provider organization) networks 64% 72% Precertification 17 16 Large case management 11 2 Other 8 10 100% 100%\n* Percent of total estimated savings from managed healthcare efforts.\nThe Company expects to continue to emphasize managed care procedures to control claim costs. Although the Company cannot accurately determine the amount of any savings which may be realized from such efforts in the future, the Company believes that it will be increasingly difficult to maintain this level of cost savings due to the efficiencies that have already been achieved.\nThe Company initiated group medical premium rate adjustments in September 1992. These adjustments were intended to offset the impact of increased benefits and to improve loss ratios. These adjustments helped stabilize loss ratios in the fourth quarter. Policy lapses increased only modestly in the fourth quarter due to the Company's aggressive conservation activities.\nInsurance and general expenses decreased $10,853,000, or 6%, in 1992 as compared to 1991. The reduction in these expenses is primarily due to the reduced level of new business being written and the corresponding cost reduction programs in the insurance units, which was partially offset by an increase in the level of expenses incurred by the Company's non-insurance subsidiaries.\nInterest expense decreased $727,000, or 25%, in 1992 as compared to 1991 due to a decrease in the weighted average notes payable outstanding and a decrease in interest rates. However, notes payable increased from December 31, 1991, as Pioneer Life Insurance Company of Illinois entered into a loan agreement in March of 1992.\nAmortization of deferred policy acquisition costs increased $4,967,000, or 5%, in 1992 as compared to 1991. In the fourth quarter of 1992 the Company wrote off approximately $30,000,000 of deferred policy acquisition costs. The adjustment was primarily the result of certain policies sold in the self-employed and small business owner market. These were policies issued without managed care and cost containment features (including scheduled benefits) which are part of all of the Company's policies now issued. The adjustment included primarily individual policy contracts issued in certain states where strict regulatory approval requirements have delayed implementation of necessary premium adjustments. In all other states, the Company sells group medical plans to the small business owner market. While these group policies are individually underwritten, they provide more latitude for expedient rate adjustments that correspond with actual claims experience.\nRecently, the Company has experienced improved persistency, primarily\non the policies issued in 1991 and 1992, which has resulted in decreased amortization of deferred acquisition costs in 1992 as compared to 1991 on this block of business. The Company continues to monitor persistency closely since general economic conditions and future premium rate adjustments could adversely impact lapses in the future. Increased lapses resulting in an increase in the amortization rate of deferred policy acquisition costs could adversely impact future earnings.\nThe Company recorded a net tax benefit for 1992 due to the operating loss incurred.\nInvestments increased during 1992 as a result of the investment of loan proceeds received in March of 1992 and a reduced level of ceded reinsurance. Premiums and other receivables, accrued investment income, and general expenses and other liabilities decreased due to reduced levels of new business. Deferred policy acquisition costs decreased as a result of the fourth quarter write-down and the decrease in 1992 new business issues. Other assets increased due to federal income tax recoverables and the prepayment of certain agent compensation.\nFederal legislation required all states to adopt certain standardized benefit provisions for the sale of Medicare supplement policies. The Company has introduced new Medicare supplement plans in response to this legislation. In addition, in 1991, the National Association of Insurance Commissioners adopted the Small Employers Availability Act (Act). The Act affects the rating and underwriting methodology that can be applied to insurance coverage sold to small employers, generally categorized as those employing 25 people or less.\nThe Company believes the Act will not have a material impact on its existing business. In response to the Act, the Company has modified its products, and will continue to modify products (if required) for sale in those states adopting the Act.\nDeferred Policy Acquisition Costs\nUnder generally accepted accounting principles, a deferred acquisition cost asset (DAC) is established to properly spread the acquisition costs for a block of policies against the expected future revenues from the policies. The acquisition costs which are capitalized and amortized consist of first year commissions in excess of renewal commissions and certain home office expenses related to selling, policy issue, and underwriting.\nThe deferred acquisition costs for accident and health policies and traditional life policies are amortized over future revenues of the business to which the costs are related. The rate of amortization depends on the expected pattern of future revenues for the block of policies. The scheduled amortization for a block of policies is established when the policies are issued.\nThe amortization schedule is based on the expected persistency of the\npolicies. The actual amortization of DAC reflects the actual persistency of the business. For example, if actual policy terminations are higher than expected, DAC will be amortized more rapidly than originally scheduled.\nEffect of Inflation\nIn pricing its insurance products, the Company gives effect to anticipated levels of inflation; however, the Company believes that the high rate of medical cost inflation during the last three years had an adverse impact on its major hospital accident and health claims experience. The Company has implemented rate increases in response to this experience.\nLiquidity and Capital Resources\nThe Company's consolidated liquidity requirements are created and met primarily by operations of its insurance subsidiaries. The primary sources of cash are premiums, investment income, proceeds from public offerings and investment sales and maturities. The primary uses of cash are operating costs, repayment of notes payable, policy acquisition costs, payments to policyholders and investment purchases.\nIn addition, liquidity requirements of the Company are created by dividend requirements of the $2.125 Preferred Stock and debt service requirements. The Company's liquidity requirements are met primarily by dividends declared by its non-insurance subsidiaries. As disclosed in Note 9 of Notes to Consolidated Financial Statements, payment of dividends by the insurance subsidiaries to the Company is subject to certain regulatory restrictions.\nThe Company's life and health insurance subsidiaries require capital to fund acquisition costs incurred in the initial year of policy issuance and to maintain adequate surplus levels for regulatory purposes. These capital requirements have been met principally from internally generated funds, including premiums and investment income, and capital provided from reinsurance and the financing or sale of agent debit balances. The Company has terminated existing financial reinsurance agreements with respect to policies issued subsequent to July 1991. The current reinsurance agreements in force have been approved by the appropriate regulatory authorities and the Company believes they meet the current NAIC model regulations. If circumstances arose that would affect the Company's continued ability to include capital provided from reinsurance in the insurance subsidiaries' statutory capital and surplus, it could have an adverse impact on the Company's business. The Company is not aware of any circumstances that would have such an effect.\nCertain subsidiaries of the Company have entered into agreements for the sale of agent debit balances. Proceeds from such sales during 1993 and 1992 were $25.4 million and $20.3 million, respectively. The Company's agent debit balance program has been reviewed without objection by applicable regulatory authorities. If restrictions are imposed on including in capital the proceeds from this type of financing in the\nfuture, the Company would consider alternative financing arrangements or discontinue its agent advancing program.\nIn the past, the Company has obtained funds from public stock and debt offerings and bank borrowings and contributed a portion of the proceeds to the insurance subsidiaries to support the growth of its insurance business. The level of premium volume of the Company's insurance subsidiaries will depend on the amount of their statutory capital and surplus. The statutory basis premium to surplus ratio for 1993 for the Company's major insurance subsidiaries were as follows: Manhattan National Life: 1.5 times; Pioneer Life Insurance Company of Illinois: 4.4 times; Continental Life & Accident Company 6.8 times; and National Group Life Insurance Company: 3.3 times. The concept of risk-based capital has been adopted for regulatory monitoring of the life and health insurance industry. The risk-based capital rules for life and health insurance companies were effective for 1993 annual statement filings.\nRisk based capital standards will be used by regulators to set in motion appropriate regulatory actions relating to insurers which show signs of weak or deteriorating conditions. The Company's insurance subsidiaries total adjusted capital, authorized control risk based capital, and related ratio by company as disclosed in the 1993 annual statement are as follows:\nAuthorized Adjusted Control Company Capital Level RBC RBC Ratio (Dollars in thousands) Pioneer Life Insurance Company of Illinois $77,460 $23,080 336%\nManhattan National Life Insurance Company 24,424 4,316 566%\nNational Group Life Insurance Company 34,756 9,016 385%\nContinental Life & Accident Company 11,791 4,996 236%\nHealth & Life Insurance Company of America 3,803 240 1,585%\nThe Company has offered agent commission financing to certain of its agents and marketing organizations which consists primarily of annualization of first year commissions. This means that when the first year premium is paid in installments, the Company will advance a percentage of the commissions that the agent would otherwise receive over the course of the first policy year. On October 31, 1990, the Company through a subsidiary entered into an agreement with an unaffiliated corporation to provide financing for its agent commission financing program through the sale of agent receivables. This financing program was replaced with an amended agreement which was executed on October 1, 1992, to provide such\nsubsidiary with the same type of financing. Pursuant to this amended agreement the termination date of the program is December 31, 1994, subject to extension or termination as provided therein.\nIn April 1992, the Company settled certain disputes with several former agents and in addition to certain cash payments issued promissory notes representing future commission. The remaining total of $1,490,000 at December 31, 1993 was repaid in January 1994.\nIn July 1993 the Company issued $57.5 million of 8% convertible subordinated debentures due 2000. Interest on the debentures is payable in January and July of each year. Net proceeds from the offering totaled approximately $54 million. The debentures are convertible into the Company's common stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share. The proceeds were used in part to repay the $15,000,000 and $10,000,000 term loans outstanding.\nIn August 1993 the Company borrowed $1,500,000 to finance the acquisition of Healthcare Review Corporation. Interest on the note is payable quarterly at six percent. The note requires principal repayments of $75,000 per quarter through July 31, 1998.\nInterest paid amounted to $1,023,000, $2,274,000 and $2,416,000 for 1993, 1992, and 1991, respectively.\nManagement believes that the diversity of the Company's investment portfolio and the liquidity attributable to the large concentration of investments in highly liquid United States government agency securities provide sufficient liquidity to meet foreseeable cash requirements. In the fourth quarter of 1992 the Company segregated the fixed maturity portfolio into two components: fixed maturities held to maturity and fixed maturities available for sale. Because the Company's insurance subsidiaries experience strong positive cash flows, including sizeable monthly cash flows from mortgage-backed securities, the Company does not expect its insurance subsidiaries to be forced to sell the held to maturity investments prior to their maturities and realize material losses or gains. However, if the Company experiences changes in credit risk, it may be required to sell assets whose fair value is less than carrying value and incur losses.\nLife insurance and annuity liabilities are generally long term in nature although subject to earlier surrender as a result of the policyholder's ability to withdraw funds or surrender the policy, subject to surrender and withdrawal penalties. The Company believes its policyholder liabilities should be backed by an investment portfolio that generates predictable investment returns. The Company seeks to limit exposure to risks associated with interest rate fluctuations by concentrating its invested assets principally in high quality, readily marketable debt securities of intermediate duration and by attempting to balance the duration of its invested assets with the estimated duration of benefit payments arising from contract liabilities.\nThe Company has no material commitments for capital expenditures at the present time. The Company acquired its corporate headquarters in Schaumburg, Illinois in January 1994 which will be primarily used for investment real estate.\nInvestment Portfolio\nAt December 31, 1993, the Company had invested assets of $674 million, compared to $568 million at December 31, 1992. The Company manages all of its investments internally with resource and evaluation assistance provided by independent investment consultants. Government and mortgage-backed obligations and corporate fixed maturity securities collectively comprised approximately 87% and 84% of the Company's investment portfolio at December 31, 1993 and 1992, respectively. The remainder of the invested assets were in short-term investments, equity securities, policy loans and mortgage loans.\nFixed Maturity Investments. With the adoption of risk based capital rules and consumer concerns over insurance company solvency and financial stability, the asset quality of insurance companies' investment portfolios has become of greater concern to policyholders and has come under closer scrutiny by insurance regulators and investors. In response, the Company reduced its investments in below-investment grade fixed maturity securities to less than 1% of its invested assets at December 31, 1993, and 3.4% at December 31, 1992, down from 4.5% at December 31, 1991, and 5.0% at December 31, 1990. These reductions resulted from sales and write-downs of the carrying value of such securities in each of these periods, and the elimination of new purchases. The Company has a policy not to invest more than 5% of its total invested assets in securities below investment grade.\nInvestments in below-investment grade fixed maturity securities generally have greater risks (and potentially greater returns) than other corporate fixed maturity investments. Risk of loss upon default by the issuer is significantly greater for these securities because they are generally unsecured and are often subordinated to other creditors of the issuer, and because these issuers usually have high levels of indebtedness and are more sensitive to adverse economic conditions, such as recession or increasing interest rates, than are investment grade issuers. Also, the market for below-investment grade securities is less liquid and not as actively traded as the market for investment grade securities.\nThe investment objectives of the Company are to maximize investment yield without sacrificing high investment quality and matched liquidity.\nThe Company continually evaluates the creditworthiness of each issuer of securities held in its portfolio. When the fair value of an individual security declines materially, or when the Company's ongoing evaluation indicates that it may be likely that the Company will be unable to realize the carrying value of its investment, significant review and analytical procedures are performed to determine the extent to which such declines are attributable to changing market expectations regarding general interest rates and inflation and other factors, such as a perceived increase in the\ncredit risk of the issuer, a general decrease in a particular industry sector or an overall economic decline.\nDeclines in fair value attributable to factors other than market expectations regarding general interest rates and inflation are reviewed and analyzed in further detail to determine if the decline in value is other than temporary, and the carrying amount of the investment is reduced to its net realizable value based upon estimated non-discounted cash flows. The amount of the reduction is reported as a realized loss on investments and the net realizable value becomes the new cost basis of the investment. In addition, the Company reverses any accrued interest income previously recorded for the investment and records future interest income only when cash is received.\nThe Company's use of non-discounted cash flows to evaluate net realizable value may result in lower realized losses in the current period than if the Company had elected to use discounting in its evaluation process. Also, yields recognized in future periods on such investments may be less than yields recognized on other investments and will be less than the yield expected when the fixed maturity security was originally purchased. The affect on net income from declines in interest income and portfolio yield from impaired securities in future periods will depend on many factors, including, in life insurance business, the level of interest rates credited to policyholder account balances. Inasmuch as interest rates credited to the Company's policyholders are typically only guaranteed for one year, the Company does not expect any material adverse affect on net income in future periods from declines in yields from impaired securities.\nMortgage-Related Securities. At December 31, 1993, the Company had $324 million, or 55%, of its fixed maturities portfolio in mortgage-related securities ($351 million at December 31, 1992). The yield characteristics of mortgage-related securities differ from those of traditional fixed income securities. The major differences typically include more frequent interest and principal payments, usually monthly, and the possiblity that prepayments of principal may be made at any time. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic, social and other factors and cannot be predicted with certainty. The yields to maturity of the mortgage-related securities will be affected by the actual rate of payment (including prepayments) of principal of the underlying mortgage loans.\nIn general, prepayments on the underlying mortgage loans, and subsequently the mortgage-related securities backed by these loans, increases when the level of prevailing interest rates declines significantly below the interest rates on such loans. When declines in interest rates occur, the proceeds from the prepayment of such securities are likely to be reinvested at lower rates than the Company was earning on such securities.\nPrior to 1991, the Company's investments in mortgage-related securities consisted primarily of pass-through certificates which provide\nfor regular monthly principal and interest payments. During 1991 and 1992, the Company restructured its portfolio by investing in principal only and inverse floaters/interest only tranches of collateralized mortgage obligations (CMOs) and accrual bonds (derivative securities) and other CMOs by selling pass-through certificates. The Company also purchased additional CMO investments with cash flows generated by policyholder premium collections, reinvestment of investment income and scheduled principal payments or maturities of investments and proceeds from the sales of fixed maturity investments, including significant sales of higher-coupon mortgage-related securities in 1991 and 1992.\nThe Company's mortgage-related securities portfolio is well diversified as to collateral, maturity/duration and other characteristics. The majority of the mortgage-related securities portfolio has the guarantee or backing of agencies of the United States government. Generally, the mortgage-related securities consist of pools of single-family, residential mortgages.\nThe derivative securities were acquired to protect the Company in the event of adverse interest rate fluctuations. The yields and fair values of the derivative securities are generally more sensitive to changes in interest rates and prepayments than other mortgage-related securities.\nAccrual bonds are CMOs structured such that the payments of coupon interest is deferred until principal payments begin on the bonds. On each accrual date, the principal balance is increased by the amount of the interest (based upon the stated coupon rate) that otherwise would have been payable. As such, these securities act much the same as zero coupon bonds until cash payments begin. Cash payments typically do not commence until earlier classes in the CMO structure have been retired, which can be significantly influenced by the prepayment experience of the underlying mortgage loan collateral in the CMO structure. Because of the zero coupon element of these securities and the potential uncertainty as to the timing of cash payments, their fair values and yields are more sensitive to changing interest rates than pass-through securities and coupon bonds.\nThe Company's mortgage-related securities portfolio at December 31, 1993, also included $37 million of CMOs and pass-through certificates issued by non-government agencies ($57 million at December 31, 1992). The Company's holdings consist solely of senior securities in the CMO structures which are collateralized by first mortgage liens on single family residences. These securities are rated AAA or AA by Standard & Poor's, or the comparable equivalent rating by another independent nationally recognized rating agency.\nThe credit worthiness of these securities is based solely on the underlying mortgage loan collateral and credit enhancements in the form of senior/subordinated structures, letters of credit, mortgage insurance or surety bonds. The underlying mortgage loan collateral principally consists of whole loan mortgages that exceed the $202,000 maximum imposed by both the Federal National Mortgage Associaton and the Federal Home Loan Mortgage Corporation and, as such, the collateral tends to be concentrated in states\nwith the greatest number of higher priced single family residences, including California, New York, New Jersey, Maryland, Virginia and Illinois. The maximum average loan-to-value ratio for the collateral is 80%.\nThe following table summarizes the components of the Company's mortgage-related securities portfolio at December 31, 1993, and December 31, 1992 (in thousands):\nDecember 31, 1993 December 31, 1992 Estimated Estimated Carrying Fair Carrying Market Value Value (1) Value Value (1) Inverse floaters and interest only CMO tranches $ 18,954 $ 16,003 $ 30,810 $ 24,632 Accrual bonds: U.S. government agency 6,968 7,386 7,852 8,215\nOther CMOs: U.S. government agency 187,871 190,141 200,860 204,161 Non-government agency 21,154 21,919 40,635 41,772 Total other CMOs 209,025 212,060 241,495 245,933\nU.S. government agency pass-through73,285 74,004 54,902 56,104 Non-government agency pass-through 15,895 16,041 16,252 16,584 Total mortgage-backed securities $324,127 $325,494 $351,311 $351,468\n(1) Fair values are generally derived from independent pricing services. Fair values for principal only and inverse floater/interest only tranches of CMOs at December 31, 1993, and 1992 reflect a discounted cash flow due to a lack of a liquid market for these securities.\nRecently Issued Accounting Standards\nFor a discussion of a new income tax accounting standard and a new reinsurance accounting standard and the impact these standards had on the financial statements of the Company, see Note 2 of Notes to Consolidated Financial Statements.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data\nConsolidated Financial Statements are included in Part IV, Item 14 of this report.\nItem 9.\nItem 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNot applicable.\nPart III\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders before April 1, 1994, in connection with the Company's 1994 annual meeting of stockholders entitled \"Election of Directors\" is incorporated herein by this reference.\nFor information on executive officers of the registrant, reference is made to the item entitled \"Executive Officers of the Registrant\" in Part I of this report.\nItem 11.\nItem 11. Executive Compensation\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders before April 1, 1994, in connection with the Company's 1994 annual meeting of stockholders entitled \"Executive Compensation\" is incorporated herein by this reference.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders before April 1, 1994, in connection with the Company's 1994 annual meeting of stockholders entitled \"Principal Holders of Securities\" is incorporated herein by this reference.\nItem 13.\nItem 13. Certain Relationships and Related Transactions\nThe section of the definitive proxy statement to be filed with the Securities and Exchange Commission and mailed to stockholders before April 1, 1994, in connection with the Company's 1994 annual meeting of stockholders entitled \"Certain Transactions\" is incorporated herein by this reference.\nPART IV\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) Documents filed as a part of this report:\nPIONEER FINANCIAL SERVICES, INC.\n1. Financial Statements\nReport of Independent Auditors . . . . . . . . . . . . Consolidated Financial Statements . . . . . . . . . . . Statements of Consolidated Operations . . . . . . Consolidated Balance Sheets . . . . . . . . . . . Statements of Consolidated Stockholders' Equity. . Statements of Consolidated Cash Flows . . . . . . Notes to Consolidated Financial Statements . . . .\n2. Financial Statement Schedules\nSchedule I - Consolidated Summary of Investments - Other Than Investments in Related Parties . . . . . .\nSchedule II - Amounts Receivable From Related Parties and Underwriters, Promoters, and Employees Other Than Related Parties . . . . . .\nSchedule III - Condensed Financial Information of Registrant - Condensed Balance Sheets . . . . . .\nSchedule III - Condensed Financial Information of Registrant - Condensed Statements of Operations . . .\nSchedule III - Condensed Financial Information of Registrant - Condensed Statements of Cash Flows. . . . . . . . . . . . . . . . . . . . . .\nSchedule III - Note to Condensed Financial Statements Schedule V - Supplementary Insurance Information. . . Schedule VI - Reinsurance . . . . . . . . . . . . . .\nSchedule VIII - Valuation and Qualifying Accounts . .\nSchedule IX - Short-Term Borrowings . . . . . . . . .\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the financial statements or notes thereto.\n3. Exhibits\nSee Exhibit Index below.\n(b) Reports on Form 8-K\nThe Company filed no reports on Form 8-K during the fourth quarter of 1993.\n(c) Index to Exhibits\nExhibit Sequentially Number Description of Document Numbered Page\n3 (a) Certificate of Incorporation of the Company (filed as Exhibit 3(a) to the Company's Registration Statement on Form S-1 [No. 33-7759] and incorporated herein by reference)\n3 (b) Amended Bylaws of the Company (filed as Exhibit 3(b) to Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (a) Certificate of Designations with respect to the Company's $2.125 Cumulative Convertible Exchangeable Preferred Stock (\"Preferred Stock\") (filed as Exhibit 4(a) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (b) Proposed form of Indenture with respect to the Company's 8 1/2% Convertible Subordinated Debentures due 2014 into which the Preferred Stock is exchangeable (filed as Exhibit 4(b) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (c) Rights Agreement dated as of December 12, 1990 between the Company and First Chicago Trust Company of New York as Rights Agent (including exhibits thereto) (filed as Exhibit 1 to the Company's registration statement on Form 8-A dated December 14, 1990 and incorporated herein by reference)\n10 (a) Form of contract with independent agents (filed as Exhibit 10(f) to the Company's Registration Statement on Form S-1 [No. 33-7759] and incorporated herein by reference)\n10 (b) Nonqualified Stock Option Plan (filed as Exhibit 10(g) to the Company's Registration Statement on Form S-1 [No. 33-7759] and incorporated herein by reference)\n10 (c) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(d) to the Company's Registration Statement on Form S-8 [No. 33-26455] and incorporated herein by reference)\n10 (d) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(c) to the Company's Registration Statement on Form S-1 [No. 33-17011] and incorporated herein by reference)\n10 (e) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(e) to the Company's registration statement on Form S-8 [No. 33-37305] and incorporated herein by reference)\n10 (f) Amended and Restated Receivables purchase agreement dated as of October 1, 1992 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed herewith)\n*10 (g) Employment Agreement dated December 3, 1993 by and between the Company and Peter W. Nauert (filed herewith)\n10 (h) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and Pioneer Life Insurance Company of Illinois (filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n10 (i) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and National Group Life (filed as Exhibit 10(w)\nto the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n*10 (j) Employment Agreement dated December 31, 1991 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(x) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n*10 (k) Amendment to Employment Agreement dated March 26, 1993 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed herewith)\n*10 (l) Employment Agreement dated December 31, 1991 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n*10 (m) Amendment to Employment Agreement dated March 26, 1993 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed herewith)\n10 (n) Credit Agreement dated as of December 22, 1993 by and among the Company and American National Bank and Trust Company of Chicago, as Agent and American National Bank and Trust Company of Chicago, Firstar Bank Milwaukee, N.A. and Bank One, Rockford, NA, as Banks (filed herewith)\n11 Statement of Computation of per share net income or loss (filed herewith) __\n21 List of subsidiaries (filed herewith) __\n23 Consent of Ernst & Young (filed herewith) __\n____________________\n* Indicates management employment contracts or compensatory plans or arrangements.\nPioneer Financial Services, Inc. and Subsidiaries\nFinancial Statements\nYear ended December 31, 1993\nContents\nReport of Independent Auditors . . . . . . . . . . . . . . .\nFinancial Statements\nStatements of Consolidated Operations . . . . . . . . . . . . Consolidated Balance Sheets . . . . . . . . . . . . . . . . . Statements of Consolidated Stockholders Equity . . . . . . . Statements of Consolidated Cash Flows . . . . . . . . . . . . Notes to Consolidated Financial Statements . . . . . . . . .\nReport of Independent Auditors\nBoard of Directors Pioneer Financial Services, Inc.\nWe have audited the accompanying consolidated balance sheets of Pioneer Financial Services, Inc. and subsidiaries as of December 31, 1993 and 1992, and the related statements of consolidated operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement\nschedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free\nof material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly,\nin all material respects, the consolidated financial position of Pioneer Financial Services, Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nERNST & YOUNG\nChicago, Illinois March 2, 1994\nPioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Operations (In Thousands, Except Per Share Amounts)\nYear ended December 31 1993 1992 1991 Revenues Premiums and policy charges (Note 5): Accident and health $ 601,684 $ 559,894 $ 593,236 Life and annuity 43,878 35,219 33,321 645,562 595,113 626,557 Net investment income (Note 3) 40,242 43,555 47,974 Other income and realized investment gains and losses (Note 3) 17,920 17,305 34,207 703,724 655,973 708,738 Benefits and expenses Benefits: Accident and health 397,963 368,046 376,820 Life and annuity 44,015 47,622 46,128 441,978 415,668 422,948 Insurance and general expenses 162,831 162,837 173,806 Interest expense (Note 7 and 10) 3,276 2,189 2,916 Amortization of deferred policy acquisition costs (Notes 3 and 8) 76,875 100,715 95,748 684,960 681,409 695,418 Income (loss) before income taxes 18,764 (25,436) 13,320 Income taxes (benefit) (Note 4): Current 10,858 2,878 7,228 Deferred (4,239) (11,355) (7,780) 6,619 (8,477) 4,448 Net income (loss) 12,145 (16,959) 8,872\nPreferred stock dividends (Note 11) 2,021 2,039 2,039 Income (loss) applicable to common stockholders $ 10,124 $ (18,998) $ 6,833\nNet income (loss) per common share: Primary $ 1.51 $ (2.85) $ 1.02 Fully diluted 1.26 (2.85) 1.02\nAverage common and common equivalent shares outstanding: Primary 6,724 6,660 6,699 Fully diluted 10,731 8,195 8,234\nSee notes to consolidated financial statements.\nPioneer Financial Services, Inc. and Subsidiaries Consolidated Balance Sheets (In Thousands, Except Share and Per Share Amounts)\nDecember 31 1993 1992 Assets Investments (Note 3): Fixed maturities: Held to maturity - principally at amortized cost (fair value: 1993 $325,540; 1992 - $434,195) $326,512 $434,726 Available for sale - at lower of aggregate amortized cost or fair value (fair value: 1993 - $ 263,263; 1992 - $39,992) 257,717 38,751 Equity securities at fair value (cost: 1993 - $12,382; 1992 $14,925) 17,436 19,537 Mortgage loans at unpaid balance 3,201 583 Policy loans at unpaid balance 23,988 21,386 Short-term investments at cost, which approximates fair value 45,352 53,366 Total investments 674,206 568,349\nCash 23,379 18,686 Premiums and other receivables, less allowance for doubtful accounts (Notes 6 and 17) 20,734 22,056 Reinsurance receivables and amounts on deposit with reinsurers (Note 2 and 5) 74,366 56,931 Accrued investment income 8,482 7,164 Deferred policy acquisition costs (Note 8) 260,432 269,674 Land, building, and equipment at cost, less accumulated depreciation (Note 17) 22,248 18,210 Deferred federal income taxes (Note 4) 3,922 - Other 20,502 17,619\n$1,108,271 $978,689\nDecember 31 1993 1992 Liabilities, redeemable preferred stock, and stockholders equity Policy liabilities (Note 2): Future policy benefits: Life $244,249 $232,940 Annuity 208,155 180,553 Accident and health 158,330 144,922 Unearned premiums 87,945 90,880 Policy and contract claims 189,389 148,141 Other 15,037 8,260 903,105 805,696 General liabilities: General expenses and other liabilities 48,442 48,011 Deferred federal income taxes (Note 4) - 159 Short-term notes payable (Note 7) 5,575 12,931 Long-term notes payable (Note 7) 1,125 25,170\nConvertible subordinated debentures (Note 10) 57,477 - Total liabilities 1,015,724 891,967\nCommitments and contingencies (Notes 4 to 9 and 14)\nRedeemable Preferred Stock, no par value (Note 11): $2.125 cumulative convertible exchangeable preferred stock: Authorized: 5,000,000 shares Issued and outstanding: (1993 - 947,000 shares; 1992 - 959,600 shares) 23,675 23,900\nStockholders equity (Notes 4 and 9 to 13): Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1993 - 6,900,000; 1992 - 6,820,000) 6,900 6,820 Additional paid-in capital 28,814 28,399 Unrealized appreciation of equity securities (Note 3) 3,285 3,044 Retained earnings 34,645 24,521 Less treasury stock at cost (1993 - 556,800 shares; 1992 - 10,600 shares) (4,772) (52) Total stockholders equity 68,872 62,732 $1,108,271 $978,689\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nPioneer Financial Services, Inc. and Subsidiaries Statements of Consolidated Cash Flows (In Thousands)\nYear ended December 31 1993 1992 1991 Operating activities Net income (loss) $ 12,145 $ (16,959)$ 8,872 Adjustments to reconcile net income or loss to net cash provided by operating activities: Decrease (increase) in premiums receivable(3,912) 5,673 6,782 Increase in policy liabilities 31,132 12,734 51,280 Deferral of policy acquisition costs (67,633) (56,936) (102,824) Amortization of deferred policy acquisition costs (Note 8) 76,875 100,715 95,748 Deferred income tax benefit (4,239) (11,355) (2,780) Change in other assets and liabilities (13,423) (10,597) (4,107) Depreciation, amortization, and accretion 9,795 10,303 2,761 Realized losses (gains) (Note 3) 1,336 47 (7,897) Net cash provided by operating activities 42,076 33,625 47,835\nInvesting activities Net decrease (increase) in short-term investments 28,792 (21,403) 57,883 Purchases of investments and loans made (382,339) (621,017) (400,871) Sales of investments 192,697 451,422 294,333 Maturities of investments and receipts from repayment of loans 118,620 151,042 32,734 Net purchases of property and equipment (3,956) (4,434) (3,470) Sale of subsidiary, net of cash sold of $166 - - 8,386 (Note 18) Purchase of subsidiaries including a cash overdraft of $1,019 (Note 18) (9,685) - - Net cash used by investing activities (55,871) (44,390) (11,005)\nFinancing activities Net proceeds from issuance of convertible subordinated debentures (Note 10) 54,055 - - Increase in notes payable - 14,030 - Repayment of notes payable (31,401) (3,900) (15,247) Proceeds from sale of agent receivables (Note 6) 25,376 20,347 36,950 Transfer of collections on previously sold agent receivables (Note 6) (22,981) (22,437) (43,539) Dividends paid (2,021) (2,039) (2,039) Stock options exercised 451 165 - Purchase of treasury stock (4,720) (52) - Retirement of preferred stock (315) - - Other 44 717 - Net cash provided (used) by financing activities 18,488 6,831 (23,875) Increase (decrease) in cash 4,693 (3,934) 12,955 Cash at beginning of year 18,686 22,620 9,665\nCash at end of year $ 23,379 $ 18,686 $ 22,620\nSee notes to consolidated financial statements.\nPioneer Financial Services, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements\n1. Accounting Policies\nPrinciples of Consolidation\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) and include the accounts and operations, after intercompany eliminations, of Pioneer Financial Services, Inc. (PFS) and its subsidiaries.\nInvestments\nPFS's fixed maturity portfolio is segregated into two components: fixed maturities held to maturity and fixed maturities available for sale. Fixed maturities, where the intent is to hold to maturity, are carried at amortized cost, adjusted for other-than-temporary impairments. In cases where there are changes in credit risk, fixed maturities that are carried at amortized cost may be liquidated prior to maturity. Fixed maturities that are available for sale are carried, on an aggregate basis, at the lower of amortized cost or fair value. Changes in aggregate unrealized depreciation on fixed maturities available for sale are reported directly in stockholders' equity, net of applicable deferred income taxes.\nThe amortized cost of fixed maturities classified as held to maturity or available for sale is adjusted for amortization of premiums and accretion of discounts to maturity, or, for mortgage-backed securities, over the estimated life of the security. Such amortization is included in net investment income. To the extent that the estimated lives of mortgage- backed securities change as a result of changes in prepayment rates, the accumulated amortization of premiums and the accretion of discounts is adjusted retrospectively with a charge or credit to current operations.\nAs regards equity securities, changes in unrealized appreciation or temporary depreciation, after deferred income tax effects, are reported directly in stockholders equity. Realized gains and losses on the sale of investments are determined on the specific identification basis and are included in other income in the statements of operations.\nRevenues\nRevenues for interest-sensitive life insurance and annuities consist of charges assessed against policy account values. For accident and health and other life insurance, premiums are recognized as revenue when due. Accident and health group association dues and fees, included in other revenues, are recognized as revenue when received.\nPioneer Financial Services, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements (consolidated)\n1. Accounting Policies (continued)\nFuture Policy Benefits\nThe liabilities for future policy benefits related to the annuity and interest-sensitive life insurance policies are calculated based on accumulated fund values. As of December 31, 1993, interest credited during the contract accumulation period ranged from 5.0% to 8.0%. Investment spreads and mortality gains are recognized as profits when realized, based on the difference between actual experience and amounts credited or charged to policies.\nThe carrying amounts of PFS's liabilities for investment-type insurance contracts were $200,894,000 and $173,930,000 at December 31, 1993 and 1992, respectively. The fair values of these liabilities at December 31, 1993 and 1992 were $191,816,000 and $165,739,000, respectively.\nThe liabilities for future policy benefits on other life and accident and health insurance policies have been computed by a net level method based on estimated future investment yield, mortality or morbidity, and withdrawals, including provisions for adverse deviation. Interest rate assumptions range from 3.5% to 8.5% depending on the year of issue. The provisions for future policy benefits and the deferral and amortization of policy acquisition costs are intended to result in benefits and expenses being associated with premiums proportionately over the policy periods.\nUnearned Premiums\nUnearned premiums are calculated using the monthly pro-rata basis.\nDeferred Policy Acquisition Costs\nCosts that vary with, and are primarily related to, the production of new business are deferred. Such costs are primarily related to accident and health business and principally include the excess of new business commissions over renewal commissions and underwriting and sales expenses.\nFor annuities and interest-sensitive life insurance policies, deferred costs are amortized generally in proportion to expected gross profits arising from the difference between investment and mortality experience and amounts credited or charged to policies. That amortization is adjusted retrospectively when estimates of current or future gross profits (including the impact of realized investment gains and losses) to be realized from a group of products are revised. For other life and accident and health policies, costs are amortized over the premium-paying period of the policies, using the same mortality or morbidity, interest, and withdrawal assumptions that are used in calculating the liabilities for future policy benefits.\n1. Accounting Policies (continued)\nThe unamortized cost of purchased insurance in force is included in deferred policy acquisition costs ($23,078,000 and $20,200,000 at December 31, 1993 and 1992, respectively). Amortization of these amounts is in relation to the present value of estimated gross profits over the estimated remaining life of the related insurance in force.\nPolicy and Contract Claims\nThe liabilities for policy and contract claims, principally accident and health, are determined using case-basis evaluations and statistical analyses based on past experience and represent estimates of the ultimate net cost of incurred claims and the related claim adjustment expenses. Although considerable variability is inherent in such estimates, management believes that these liabilities are adequate. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations. Reinsurance\nReinsurance premiums, commissions, expense reimbursements, and receivables related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums reinsured to other companies have been reported as reductions of premium revenues. Amounts recoverable for reinsurance related to future policy benefits, unearned premium reserves, and claim liabilities have been reported as reinsurance receivables; expense allowances received in connection with reinsurance have been accounted for as a reduction of the related deferred policy acquisition costs and are deferred and amortized accordingly.\nAcquisition costs relating to the production of new business result in a reduction of statutory-basis net income. PFS had entered into certain financial reinsurance agreements that have the effect of deferring this statutory-basis reduction and amortizing costs over future periods. The remaining effect of such reinsurance has been eliminated from the accompanying consolidated financial statements.\n1. Accounting Policies (continued)\nFederal Income Taxes\nFederal income tax provisions are based on income or loss reported for financial statement purposes and tax laws and rates in effect for the years presented. For 1992 and 1991, deferred federal income taxes were provided for the differences between the recognition of income and loss determined for financial reporting purposes and income tax purposes. Effective January 1, 1993, deferred federal income taxes have been provided using the liability method an accordance with Financial Accounting Standards Board (FASB) Statement No. 109 \"Accounting for Income Taxes\" (See Note 2). Under this method deferred tax assets and liabilities are determined based on the differences between their financial reporting and their tax bases and are measured using enacted tax rates.\nDepreciation\nBuilding and equipment are recorded at cost and are depreciated using principally the straight-line method.\nNet Income or Loss Per Common Share\nPrimary net income or loss per share of Common Stock is determined by dividing net income or loss, less dividends on Preferred Stock, by the weighted-average number of Common Stock and Common Stock equivalents (dilutive stock options) outstanding. Where the effect of Common Stock equivalents on net income or loss per share would be antidilutive, they are excluded from the average shares outstanding. Fully diluted net income or loss per share is computed as if the Preferred Stock and Convertible Subordinated Debentures had been converted to Common Stock. Where the effect of the assumed conversion on net income or loss per share would be antidilutive, fully diluted net income or loss per share represents the primary amount.\n1. Accounting Policies (continued)\nCost in Excess of Net Assets of Companies Acquired\nThe cost in excess of net assets of companies acquired (goodwill) ($5,449,000 and $3,776,000 at December 31, 1993 and 1992, respectively) is included in other assets and is being amortized principally on a straight- line basis over periods from seven to forty years.\nTreasury Stock\nThe board of directors has authorized PFS to buy back shares of its own common and preferred stock on the open market from time to time. During 1993 and 1992, PFS repurchased 546,200 and 10,600 shares, respectively, of their common stock. During 1993, PFS repurchased 12,600 shares of their preferred stock. Treasury stock is accounted for using the cost method.\nCash Flow Information\nCash includes cash on hand and demand deposits.\nFair Values of Financial Instruments\nThe following methods and assumptions were used by PFS in estimating its fair values for financial instruments:\nCash, short-term investments, short-term notes payable, and accrued investment income: The carrying amounts reported in the balance sheets for these instruments approximate their fair values.\nInvestment securities: Fair values for fixed maturity securities (including redeemable preferred stocks) are based on quoted market prices, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from\nindependent pricing services, or, in the case of private placements, are estimated by discounting expected future cash flows using a current market rate applicable to the yield,quality, and maturity of the investments. The fair values for equity securities are based on quoted market prices and are recognized in the balance sheets.\nMortgage loans and policy loans: The carrying amount of PFS's mortgage loans approximates their fair values. The fair values for policy loans are estimated using capitalization of earnings methods, using interest rates currently being offered for similar loans to borrowers with similar credit ratings.\nInvestment contracts: Fair values for PFS's liabilities under investment- type insurance contracts are based on current cash surrender values.\nFair values for PFS's insurance policies other than investment contracts are not required to be disclosed. However, the fair values of liabilities under all insurance policies are taken into consideration in PFS's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance policies.\nLong-term notes payable: The fair value of PFS's long-term notes payable approximates the carrying value.\nConvertible subordinated debentures: The fair value of PFS's convertible subordinated debentures is based on quoted market prices.\nNew Accounting Standard\nIn 1993 the FASB issued Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which PFS must adopt prospectively effective January 1, 1994. Under the new rules, fixed maturities that PFS has both the positive intent and ability to hold to maturity will be carried at amortized cost. Fixed maturities that PFS does not have the positive intent and ability to hold to maturity and all\nmarketable equity securities will be classified as available-for-sale or trading and carried at fair value. Unrealized holding gains and losses on securities classified as available-for-sale will be included as a separate component of stockholders' equity. Unrealized holding gains and losses on securities classified as trading will be reported in earnings. PFS does not anticipate categorizing any fixed maturities as trading.\nIn connection with the adoption of the Statement No. 115, PFS may reclassify certain investments in fixed maturities between the available for sale and held to maturity categories. Accordingly, as of January 1, 1994, although the carrying value of investments in fixed maturities is expected to increase based on the December 31, 1993 fair values, the net effect on stockholders' equity has not been determined. Previously reported financial statements are not permitted to be restated for this Statement.\nReclassifications\nCertain amounts in the 1991 and 1992 financial statements have been reclassified to conform to the 1993 presentation.\n2. Changes in Accounting Principles\nFederal Income Taxes\nEffective January 1, 1993, PFS changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes\". As permitted under the new rules, prior years' financial statements have not been restated.\nThe cumulative effect of adopting Statement No. 109 as of January 1, 1993 was not significant and has not been separately disclosed (See Note 4 for further income tax disclosures).\nReinsurance\nEffective January 1, 1993, PFS changed its method of accounting for reinsurance contracts in accordance with FASB Statement No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long- Duration Contracts\". Under Statement No. 113, all assets and liabilities related to reinsured insurance contracts are reported on a gross basis rather than the previous practice of reporting such assets and liabilities net of reinsurance.\nThe effect of adopting Statement No. 113 was to increase both assets and liabilities by $19,453,000 and $16,391,000 at December 31, 1993 and 1992, respectively. The amounts recoverable from reinsurers are now classified as reinsurance receivables on the balance sheets. As permitted under Statement No. 113, the accompanying December 31, 1992 balance sheet has been reclassified to the gross basis. The adoption of Statement No. 113 had no effect on net income.\n3. Investments\nRealized investment gains (losses), including provisions for losses on investments held, and unrealized appreciation (depreciation) on equity securities, fixed maturities, and other investments are summarized as follows:\nFixed Equity Maturities Securities Other Total (In Thousands) Realized $ (1,638) $ 293 $ 9 $(1,336) Unrealized 3,864 442 - 4,306 $ 2,226 $ 735 $ 9 2,970\nRealized $ (91) $ 44 $ - $ (47) Unrealized (11,144) 6,998 - (4,146) $(11,235) $ 7,042 $ - $(4,193)\nRealized $ 7,280 $ (244) $ 861 $ 7,897 Unrealized 15,379 3,899 - 19,278 $ 22,659 $ 3,655 $ 861 $ 27,175\nFor annuities and interest-sensitive life insurance policies, GAAP requires that deferred policy acquisition costs be amortized in proportion to the estimated profits, including realized investment gains, expected to be realized over the life of the policies. In 1991, PFS sold investments related to this life and annuity business and realized a substantial amount of gains. As required by GAAP, realizing these higher-than-expected gains caused additional deferred policy acquisition cost amortization totaling $3,800,000 in 1991.\nAt December 31, 1993 and 1992, the allowance for losses on investments held amounted to $4,200,000 and $1,900,000, respectively.\nAt December 31, 1993, gross unrealized appreciation pertaining to equity securities was $5,067,000 and gross unrealized depreciation was $13,000. Deferred taxes of $1,769,000 and $1,568,000 have been provided on the net unrealized appreciation at December 31, 1993 and 1992, respectively.\nA comparison of amortized cost to fair value of fixed maturity investments by category is as follows:\nGross Gross Amortized UnrealizedUnrealized Fair Cost Gains Losses Value\n(In Thousands) At December 31, 1993: Held to Maturity\nU.S. Treasury $ 9,124 $ 100 $ (61) $ 9,163 States and political subdivisions 5,200 - - 5,200 Corporate securities 119,276 2,653 (312) 121,617 Mortgage-backed securities 192,912 1,908 (5,260) 189,560 $326,512 $4,661 $(5,633) $325,540\nAvailable for Sale\nU.S. Treasury $ 26,894 $ 570 $ (26) $ 27,438 States and political subdivisions 21,571 121 - 21,692 Foreign governments 4,056 2 (119) 3,939 Corporate securities 73,981 744 (465) 74,260 Mortgage-backed securities 131,215 5,029 (310) 135,934 $257,717 $6,466 $ (920) $263,263\nGross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value\n(In Thousands) At December 31, 1992: Held to Maturity\nU.S. Treasury $ 15,363 $ 406 $ (71) $ 15,698 States and political subdivisions 199 12 - 211 Corporate securities 98,836 1,344 (1,366) 98,814 Mortgage-backed securities 320,328 7,140 (7,996) 319,472 $434,726 $8,902 $(9,433) $434,195 Available for Sale\nU.S. Treasury $ 1,425 $ 109 $ - $ 1,534 Corporate securities 6,343 181 (62) 6,462 Mortgage-backed securities 30,983 1,263 (250) 31,996 $ 38,751 $1,553 $(312) $ 39,992\nThe amortized cost and fair value of fixed maturities at December 31, 1993, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.\nAmortized Fair Cost Value Held to Maturity: (In Thousands)\nDue in 1994 $ 657 $ 673 Due 1995-1998 16,707 17,254 Due 1999-2003 67,455 68,611 Due after 2003 48,781 49,442 Mortgage-backed securities 192,912 189,560 $326,512 $325,540\nAvailable for Sale:\nDue in 1994 $ 2,308 $ 2,378 Due 1995-1998 36,109 36,544 Due 1999-2003 61,750 62,036 Due after 2003 26,335 26,371 Mortgage-backed securities 131,215 135,934 $257,717 $263,263\nThe fair value of PFS's investment in policy loans was estimated to be $21,011,000 and $18,037,000 at December 31, 1993 and 1992, respectively.\nProceeds from sales of investments (principally fixed maturities) during 1993, 1992 and 1991 were $192,697,000, $451,422,000 and $294,333,000, respectively. Gross gains of $10,834,000, $8,073,000 and $7,808,000 and gross losses of $12,472,000, $8,164,000 and $528,000 were realized on fixed maturity sales in 1993, 1992 and 1991, respectively.\nMajor categories of net investment income are summarized as follows:\n1993 1992 1991 (In Thousands)\nFixed maturities $34,529 $39,384 $38,687 Short-term investments 2,691 2,083 6,311 Other 4,069 3,733 4,079 Total investment income 41,289 45,200 49,077 Investment expenses (1,047) (1,645) (1,103) Net investment income $40,242 $43,555 $47,974\nAt December 31, 1993, securities with a carrying value of $92,624,000 were on deposit with various government authorities to meet regulatory requirements.\nAt December 31, 1993, the carrying value of investments in any one entity and/or in their affiliates which exceeded 10% of PFS s consolidated stockholders equity were as follows:\nFixed Maturities Ford Capital $18,684,000 GMAC 17,472,000 State of Washington 10,023,000 Associates Corporation 7,242,000\nAt December 31, 1993, PFS held unrated or less-than-investment-grade securities of $803,000, net of reserves for losses, with an aggregate fair value of $824,000. Those holdings amounted to less than 1% of PFS s total investments at December 31, 1993.\nAt December 31, 1993, fixed maturities with a carrying value of $18,129,000 had been non-income producing for the preceding 12-month period.\n4. Federal Income Taxes\nAs discussed in Note 2, PFS adopted FASB Statement No. 109 as of January 1, 1993. The cumulative effect of the change in accounting for\nincome taxes was not significant. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of PFS's deferred tax liabilities and assets as of December 31, 1993 are as follows (in thousands):\nDeferred tax liabilities\nDeferred policy acquisition costs $86,545 Net unrealized appreciaton on marketable equity securities 1,769 Other 1,367 Total deferred tax liabilities 89,681\nDeferred tax assets Policy liabilities 77,493\nFinancial reinsurance 11,150 Other 8,833 Total deferred tax assets 97,476 Valuation allowance for deferred tax assets (3,873)\nDeferred tax assets net of valuation allowance allowance 93,603 Net deferred tax asset $ 3,922\nThe nature of PFS's deferred tax assets and liabilities are such that the reversal pattern for these temporary differences should generally result in realization of PFS's deferred tax assets. PFS establishes a valuation allowance for any portion of the deferred tax asset that management believes may not be realized. In 1993, the valuation allowance was increased by $1,221,000 principally due to the acquisition of Continental Life & Accident Company (See Note 18).\nThe deferred tax benefit for 1992 and 1991 includes the effects of the following items:\n1992 1991 (Dollars in thousands) Deferred policy acquisition costs $(16,232) $ (440)\nPolicy liabilities 2,966 (5,967) Decrease in operating loss carryforward 143 2,050 General expenses 1,537 522 Financial statement capital gains greater than tax capital gains 148 743 Other 83 312 Deferred federal income tax benefit $(11,355) $(2,780)\nPFS s effective federal income tax rate varied from the statutory federal income tax rate as follows: Deferred Method Liability Method 1993 1992 1991 Amount % Amount % Amount % (Dollars in Thousands)\nStatutory federal income tax rate applied to income or loss before income taxes $6,567 35.0% $(8,648) 34.0% $ 4,529 34.0% Nondeductible goodwill amortization 319 1.7 192 (.8) 212 1.6 Realized gain on sale of subsidiary in excess of tax-basis gain (Note 18) - - - - (247) (1.9) Tax exempt interest (99) (.5) - - - - Other (168) (.9) (21) .1 (46) (.3) Income taxes (benefit) and effective rate $ 6,619 35.3% $(8,477) 33.3% $ 4,448 33.4%\nTaxes paid amounted to $5,735,000, $8,828,000, and $2,566,000 for 1993, 1992, and 1991, respectively.\nUnder pre-1984 life insurance company income tax laws, a portion of a life insurance company s gain from operations was not subjected to current income taxation but was accumulated, for tax purposes, in a memorandum account designated as the policyholders surplus account. The balance in this account at December 31, 1993 for PFS s life insurance subsidiaries was $10,040,000. Should the policyholders surplus accounts of PFS s life insurance subsidiaries exceed their respective maximums, or should distributions in excess of their tax-basis shareholders surplus account be made by the life insurance subsidiaries, such excess or distribution would be subject to federal income taxes at rates then in effect. Deferred taxes of $3,500,000 have not been provided on amounts included in the policyholders surplus accounts, since PFS contemplates no such taxable events in the foreseeable future.\nAs of December 31, 1993, PFS s life insurance subsidiaries had combined tax-basis shareholders surplus accounts of $36,100,000. Distributions up to that amount would result in no income tax liability.\n5. Reinsurance\nPFS s insurance subsidiaries reinsure risks with other companies to permit the recovery of a portion of the direct losses. These reinsured risks are treated as though, to the extent of the reinsurance, they are risks for which the subsidiaries are not liable. PFS remains liable to the extent that the reinsuring companies do not meet their obligations under these reinsurance treaties.\nPFS's premiums were reduced for reinsurance premiums by $40,592,000, $30,469,000, and $33,789,000 in 1993, 1992, and 1991, respectively. Under various reinsurance arrangements, PFS's premiums were increased by $19,338,000, $15,403,000, and $13,933,000 in 1993, 1992, and 1991, respectively. PFS's policy benefits have been reduced for reinsurance recoveries of $21,871,000 in 1993, $22,171,000 in 1992, and $28,714,000 in 1991. At December 31, 1993, approximately 67% of PFS's reinsurance receivables and amounts on deposit with reinsurers were due from Employers Reinsurance Corporation.\n6. Sale of Agent Receivables\nIn 1993, 1992, and 1991 a subsidiary of PFS sold agent receivables to an unaffiliated company for proceeds of $25,376,000, $20,347,000, and $36,950,000, respectively.\nThe outstanding balances of such agent receivables sold that remained uncollected at December 31, 1993 and 1992 were $9,815,000 and $6,339,000, respectively. PFS remains subject to a maximum credit exposure under this agreement amounting to 10% of agent receivables at December 31, 1993.\n7. Notes Payable\nIn 1992, PFS settled certain disputes with several former agents and in addition to certain cash payments issued promissory notes representing future commissions. A final payment of $1,490,000 is payable for these notes in 1994.\nAt December 31, 1993, PFS had $3,785,000 of short-term debt liability for which a PFS agency subsidiary s future renewal commissions were pledged as collateral.\nAt December 31, 1993, a PFS subsidiary had an unsecured loan of $1,425,000. The portion of the loan due in 1994 of $300,000 is included in short-term notes payable. The remainder of the note is included in long-term notes payable. The note bears interest currently at 6% per annum and is payable quarterly with the final payment due July 1998.\nInterest paid amounted to $1,023,000, $2,274,000, and $2,416,000 for 1993, 1992, and 1991, respectively.\n8. Accident and Health Business\nIn making the determination that policy liabilities, future premiums, and anticipated investment income will be adequate to provide for future claims and expenses (including the amortization of deferred policy acquisition costs), PFS has made assumptions with regard to each of these items. Although there is significant variability inherent in these estimates, management believes that these assumptions are reasonable.\nPursuant to an actuarial study performed in the fourth quarter of 1992, PFS revised certain of these assumptions to reflect present and anticipated future experience. This study resulted in increased amortization of deferred policy acquisition costs of approximately $30,000,000 in the fourth quarter of 1992.\n9. Statutory-Basis Financial Information\nThe following tables compare combined net income and stockholders' equity for PFS's insurance subsidiaries determined on the basis as prescribed or permitted by regulatory authorities (statutory basis) with consolidated net income (loss) and stockholders' equity reported in accordance with GAAP. Statutory basis accounting emphasizes solvency rather than matching revenues and expenses during an accounting period. The significant differences between statutory basis accounting and GAAP are as follows:\nDeferred Policy Acquisition Costs. Costs of acquiring new policies are expensed when incurred (statutory basis) rather than capitalized and amortized over the term of the related polices (GAAP).\nPolicy Liabilities. Certain policy liabilities are calculated based on statutorily required methods and assumptions (statutory basis) rather than on estimated expected experience or, for annuity and interest-sensitive life insurance, actual account balances (GAAP).\nFinancial Reinsurance. The effects of certain financial reinsurance transactions are included in the statutory basis financial statements but are eliminated from the GAAP financial statements.\nDeferred Federal Income Taxes. Deferred federal income taxes are not provided on a statutory basis for differences between financial statement and tax return amounts.\nSurplus Notes. Surplus notes are reported in capital and surplus (statutory basis) rather than as liabilities (GAAP).\nNon-insurance Companies' Equity. Contributions by PFS to the capital and surplus of its insurance subsidiaries increases the stockholders' equity of those insurance subsidiaries on a statutory basis but does not effect the consolidated stockholders' equity on a GAAP basis.\n1993 1992 1991 (in thousands)\nCombined net income on a statutory basis $10,155 $ 3,629 $15,150\nAdjustments for: Deferred policy acquisition costs (12,842) (43,779) 7,076 Policy liabilities (18,494) (19,957) (28,530) Financial reinsurance 34,017 33,118 3,862 Deferred federal income taxes 4,239 11,355 2,780 Non-insurance companies, eliminations, and other adjustments (4,930) (1,325) 8,534\nConsolidated net income (loss) in accordance with GAAP $12,145 $(16,959) $ 8,872\nDecember 31 1993 1992 (in thousands)\nCombined stockholders' equity on a statutory basis $ 106,567 $ 82,432\nAdjustments for: Deferred policy acquisition costs 260,432 269,674 Policy liabilities (206,966) (184,862) Financial reinsurance (30,292) (64,309) Deferred federal income taxes 3,922 (159) Non-admitted assets 11,743 19,160 Surplus - (29,128) Non-insurance companies' equity, eliminations, and other adjustments (76,534) (30,076)\nConsolidated stockholders' equity in accordance with GAAP $ 68,872 $ 62,732\nDividends from PFS's insurance subsidiaries are limited to the greater of the prior-year statutory-basis net gain from operations or 10% of statutory-basis surplus. The total amount of dividends that could be paid without regulatory approval was $10,117,000 at December 31, 1993. At December 31, 1993, PFS's retained earnings is $20,861,000 in excess of the combined statutory-basis unassigned surplus of the insurance subsidiaries.\nPFS is required to maintain adequate amounts of statutory-basis capital and surplus to satisfy regulatory requirements and provide capacity for production of new business. Acquisition costs relating to the production of new business result in a reduction of statutory-basis net income and capital and surplus.\n10. Convertible Subordinated Debentures\nIn July 1993 PFS issued $57,477,000 of 8% convertible subordinated debentures due in 2000. Interest on the debentures is payable in January and July of each year. Net proceeds from the offering totaled approximately $54,000,000 and were used, in part, to repay the long-term notes payable. The debentures are convertible into PFS's Common Stock at any time prior to maturity, unless previously redeemed, at a conversion price of $11.75 per share. The fair value of the debentures was $70,122,000 at December 31, 1993.\nThe debentures are redeemable by PFS under certain conditions after July 1996.\nAt December 31, 1993, 4,891,660 shares of PFS's Common Stock were reserved for conversion of the outstanding convertible subordinated debentures.\n11. Redeemable Preferred Stock\nIn 1989, PFS issued 1,000,000 shares of $2.125 Cumulative Convertible Exchangeable Preferred Stock. The proceeds of the public offering were $23,337,000 after reduction for expenses of $1,663,000, which expenses were charged to additional paid-in capital. The Preferred Stock is carried on PFS s balance sheet at the redemption and liquidation value of $25 per share.\nEach share of Preferred Stock is convertible by the holders at any time into 1.6 shares of PFS Common Stock. Annual cumulative dividends of $2.125 per share are payable quarterly. The preferred stock is nonvoting unless dividends are in arrears. At December 31, 1993, 1,515,200 shares of PFS's Common Stock were reserved for conversion of the outstanding preferred stock.\nThe Preferred Stock is redeemable at the option of the holders upon certain acquisitions or other business combinations involving PFS Common Stock.\nThe Preferred Stock is redeemable by PFS at redemption prices of $26.275 per share in 1993, declining to $25 in 1999. The Preferred Stock is exchangeable in whole at PFS s option on any dividend payment date for PFS s 8 1/2% Convertible Subordinated Debentures due in 2014 at the rate of $25 principal amount of Subordinated Debentures for each share of Preferred Stock.\n12. Shareholder Rights Agreement\nIn 1990, PFS distributed one preferred share purchase right for each outstanding share of Common Stock. The rights are intended to cause substantial dilution to a person or group that attempts to acquire PFS on terms not approved by PFS s directors. The rights expire in 2000 or PFS may redeem the rights prior to exercise for $.01 per right.\nThe rights are not exercisable unless a person or group acquires, or offers to acquire, 20% or more of PFS s Common Stock under certain circumstances. The rights, when exercisable, entitle the holder to purchase one-tenth of a share of a new series of PFS Series A Junior Preferred Stock at a purchase price of $45. Such preferred shares, of which 2,000,000 are authorized, would be voting and would be entitled to distributions that are ten times the distributions to common shareholders. Subsequent to exercise of the rights, in the event of certain business combinations involving PFS, a holder of rights would have the right to receive PFS Common Stock with a value of two times the exercise price of the rights.\n13. Stock Options and Rights\nPFS has a nonqualified stock option plan principally for directors and key employees of PFS and its subsidiaries. PFS s Board of Directors grants the options and specifies the conditions of the options. Options expire ten years after grant. Information with respect to these options is as follows:\n1993 1992 Number Number of Exercise of Exercise Shares Price Shares Price\nOptions outstanding at beginning of year 594,250 $5.50-$12.00 799,750 $5.50- $12.00 Granted 225,000 5.50 35,000 7.25 Exercised 72,000 5.50- 12.00 30,000 5.50 Canceled/repurchased 14,000 5.50 210,000 5.50-12.00 Options outstanding at end of year 733,250 $5.50-$12.00 594,250 $5.50-$12.00\nOptions exercisable at end of year 573,250 471,750\nUnoptioned shares available for granting of options 22,900 233,900\n14. Commitments and Contingencies\nPFS and its subsidiaries are named as defendants in various legal actions, some claiming significant damages, arising primarily from claims under insurance policies, disputes with agents, and other matters. PFS s management and its legal counsel are of the opinion that the disposition of these actions will not have a material adverse effect on PFS s financial position.\nPFS leases various office facilities and computer equipment under noncancelable operating leases on an annual basis. Rent expense was $4,516,000, $3,700,000, and $3,653,000 in 1993, 1992, and 1991, respectively. Minimum future rental commitments in connection with noncancelable operating leases are as follows:\n1994 $2,075,000 1995 1,637,000 1996 969,000 1997 619,000 1998 130,000\nPFS has entered into employment agreements with certain officers.\n15. Benefit Plan\nPFS has a defined-contribution employee benefit plan that covers substantially all home office employees who have attained age 21 and completed one year of service. Plan participants may contribute from 1% to 10% of their total compensation subject to an annual maximum. The plan also provides for PFS to match participants contributions up to $1,000 per year and 50% of participants contributions above $1,000 up to the annual Internal Revenue Service limit ($8,994 in 1993). PFS makes employer contributions to the plan in cash or in PFS Common Stock at the discretion of PFS s Board of Directors. At December 31, 1993 the Plan's assets included PFS Common Stock of $3,478,000, at fair value. PFS's contibutions charged to operations were $1,073,000 in 1993, $852,000 in 1992, and $831,000 in 1991.\nA PFS subsidiary, which owns insurance and agency companies, had a stock purchase plan that allowed certain eligible agents to purchase common stock in the subsidiary at the subsidiary s per share book value. The plan was terminated in November 1992. In accordance with the plan's provisions, agents became fully vested. Eligible agents were given the option to participate in a new agent stock purchase plan. This new plan allows agents to purchase PFS Common Stock. Stock purchases are limited to a specific\npercentage of the agent's commission as determined by PFS but in no event to be less than 3%. Under the plan the agents are also credited with additional shares of PFS Common Stock as determined by PFS. In 1993 and 1992, 8,057 shares and 163,566 shares, respectively, of PFS Common Stock were issued under this plan. The subsidiary received proceeds of $499,000 in 1991 relating to the minority stock sales and paid $353,000 in 1992, and $1,862,000 in 1991 relating to repurchases of these shares from the agents at book value.\nIn addition, in 1991, in connection with stock option agreements, the subsidiary issued shares to agents. Proceeds on these sales amounted to $559,000 and a charge to operations of $47,000 was recognized. The subsidiary subsequently repurchased the shares in 1991 at book value in the amount of $606,000.\n16. Related Party Transactions\nPFS paid, on a per use basis, a transportation company owned by an officer, a total of $81,000, $127,000, and $130,000 in 1993, 1992, and 1991, respectively, for transportation of employees and agents.\nIn 1993, certain of PFS's marketing subsidiaries paid rent of approximately $107,000 and parking fees of approximately $12,000 to a partnership in which an officer owns a 50% interest. PFS believes that the rates charged to PFS's subsidiaries were the same as those charged to unaffiliated third parties.\nIn 1991, PFS paid commissions of $2,135,000 to an agent training company. That company s expenses included distributions to the agents, the cost of marketing leads purchased from PFS of $774,000 in 1991, and training and other expenses. Certain officers had interests in the agent training company.\nIn 1991 PFS paid a company in which certain officers had interests, $2,450,000 for telecommunication, printing, and mailing services.\n17. Allowances and Accumulated Depreciation\nAllowances for doubtful accounts related to other receivables amounted to $1,271,000 at December 31, 1993 and $1,504,000 at December 31, 1992.\nAccumulated depreciation related to building and equipment amounted to $16,891,000 at December 31, 1993 and $11,646,000 at December 31, 1992.\n18. Purchase and Sale of Subsidiaries\nIn August 1993, PFS purchased 80% of the outstanding common stock of Continental Life & Accident Company and 100% of the outstanding common stock of Continental Marketing Corporation for $7,100,000 in cash. The total assets acquired at the purchase date were approximately $80,000,000.\nAlso in August 1993, PFS purchased Healthcare Review Corporation, a managed care company for $1,566,000 in cash. The total assets acquired at the purchase date were approximately $2,000,000.\nRevenues included in PFS's 1993 consolidated statements of operations relating to these acquired entities were $25,671,000. The operations of the entities did not have a material effect on PFS's 1993 net income.\nIn September 1991, PFS sold a subsidiary for proceeds of $8,552,000 and recorded a gain of $708,000. Revenues included in PFS's consolidated statements of operations relating to the subsidiary's operations were $4,689,000 in 1991. The subsidiary represented a portion of the life and annuity segment.\n19. Segment Information\nPFS has three business segments: insurance, managed care and marketing. The segments are based on PFS's strategic business units.\nAllocations of investment income and certain general expenses are based on various assumptions and estimates, and reported operating results by segment would change if different methods were applied. Assets are not individually identifiable by segment and have been allocated based on the amount of policy liabilities by segment and by other formulas. Depreciation expense and capital expenditures are not considered material. Realized investment gains and losses are allocated to the appropriate segment. General corporate expenses are not allocated to the individual segments. Revenues, income or loss before income taxes, and identifiable assets by business segment are as follows:\nRevenues 1993 1992 1991 (in thousands) Insurance: Accident and health $ 611,822 $ 572,280 $ 612,215 Life and annuity 72,376 68,411 80,059 Marketing: Unaffiliated 15,020 13,361 14,630 Inter-segment 30,439 26,500 35,054 Managed care: Unaffiliated 4,506 1,921 1,834 Inter-segment 4,358 2,041 409 738,521 684,514 744,201 Eliminations 34,797 28,541 35,463 Total $ 703,724 $ 655,973 $ 708,738\nIncome (loss) before income taxes\nInsurance: Accident and health $ 8,578 $ (26,613) $ 1,886 Life and annuity 7,623 340 5,838 Marketing 10,205 3,345 8,556 Managed care (1,211) 335 62 Corporate expenses (6,431) (2,843) (3,022) Total $ 18,764 $ (25,436) $ 13,320\nIdentifiable assets at year-end\nInsurance: Accident and health $ 571,169 $ 489,053 $ 496,493 Life and annuity 514,154 478,529 460,752 Marketing 18,244 9,590 10,585 Managed care 4,704 1,517 1,360 Total $1,108,271 $ 978,689 $ 969,190\n20. Credit Arrangements\nPFS has a line of credit arrangement for short-term borrowings with three banks amounting to $20,000,000 through April 1996, all of which all was unused at December 31, 1993. The line of credit arrangement can be terminated, in accordance with the agreement, at PFS's option.\n21. Quarterly Financial Data (Unaudited)\nA summary of unaudited quarterly results of operations for 1993 and 1992 is as follows:\n1st 2nd 3rd 4th Premiums and policy charges $155,343 $154,189 $154,132 $181,898\nNet investment income and other 14,369 13,928 15,802 14,063\nNet income 2,295 2,627 3,128 4,095\nNet income per share: Primary .26 .31 .40 .54 Fully diluted .26 .31 .31 .37\n1st 2nd 3rd 4th Premiums and policy charges $144,054 $149,969 $143,973 $157,117\nNet investment income and other 17,131 17,286 14,876 11,567\nNet income (loss) 1,495 357 710 (19,521)\nNet income (loss) per share: Primary .15 (.02) .03 (2.98) Fully diluted .15 (.02) .03 (2.98)\nSee Note 8 for a discussion of a 1992 fourth quarter adjustment.\nSCHEDULE I\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES\nDecember 31, 1993 Amount Shown in the Consolidated Amortized Fair Balance Type of Investment Cost Value Sheet (in thousands) Fixed maturities to be held to maturity: U.S. Treasury $ 9,124 $ 9,163 $ 9,124 States and political subdivisions 5,200 5,200 5,200 Corporate securities 119,276 121,617 119,276 Mortgage-backed securities 192,912 189,560 192,912 TOTAL FIXED MATURITIES TO BE HELD TO MATURITY 326,512 $325,540 326,512\nFixed maturities available for sale: U.S. Treasury 26,894 $ 27,438 26,894 States and political subdivisions 21,571 21,692 21,571 Foreign governments 4,056 3,939 4,056 Corporate securities 73,981 74,260 73,981 Mortgage-backed securities 131,215 135,934 131,215 TOTAL FIXED MATURITIES AVAILABLE FOR SALE 257,717 $263,263 257,717\nEquity securities: Common stocks: Banks, trusts, and insurance companies 6,632 $ 11,536 11,536 Nonredeemable preferred stocks 5,750 5,900 5,900\nTOTAL EQUITY SECURITIES 12,382 $ 17,436 17,436\nMortgage loans on real estate 3,201 3,201 Policy loans 23,988 23,988 Short-term investments 45,352 45,352\nTOTAL INVESTMENTS $669,152 $674,206\nSCHEDULE II\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nAMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\nBalance at Balance Beginning of at End of Year Additions Collected Year (in thousands)\nYear Ended December 31, 1993\nTim O'Keefe mortgage loan from Pioneer Life Insurance Co. due October, 1997 $ - $140 $ 2 $138\nYear Ended December 31, 1992: None\nYear Ended December 31, 1991:\nWilliam McRee note payable to Design Benefit Plans, Inc. (formerly National Group Marketing)-- 5% due on demand $125 $ - $125 $ -\nSCHEDULE III\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS (In thousands, except share and per share amounts) December 31 1993 1992 ASSETS Investments in subsidiaries* $107,620 $ 83,606 Cash 1,711 543 Note receivable and accrued interest from Pioneer Life Insurance Company of Illinois (PLIC)* - 29,128 Notes receivable from United Group Holdings, Inc. (UGH)* 37,495 - Other notes receivable from subsidiaries* 403 3,994 Due from affiliates* 1,014 1,190 Prepaid expenses 573 454 Deferred debenture offering expenses 3,799 - Other assets 363 181 $152,978 $119,096\nLIABILITIES, REDEEMABLE PREFERRED STOCK AND, STOCKHOLDERS' EQUITY Liabilities: General expenses and other liabilities $ 2,444 $ 264 Preferred stock dividends payable 510 510 Short-term notes payable - 7,850 Long-term notes payable - 23,750 Convertible subordinated debentures 57,477 - 60,431 32,374 Redeemable Preferred Stock, no par value: $2.125 cumulative convertible exchangeable preferred stock Authorized: 5,000,000 shares Issued and outstanding: (1993 - 947,000 shares;23,675 23,990 1992 - 959,600 shares)\nStockholders' equity: Common Stock, $1 par value: Authorized: 20,000,000 shares Issued, including shares in treasury (1993 - 6,900,000 shares; 1992 - 6,820,000 shares) 6,900 6,820 Additional paid-in capital 28,814 28,399 Unrealized appreciation of equity securities 3,285 3,044 Retained earnings 34,645 24,521 Less treasury stock at cost (1993 - 556,800 shares; 1992 - 10,600 shares) (4,772) (52) Total stockholders' equity 68,872 62,732 $152,978 $119,096\nSee note to condensed financial statements.\n*Eliminated in consolidation.\nSCHEDULE III\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued\nCONDENSED STATEMENTS OF OPERATIONS (In thousands)\nYear Ended December 31 1993 1992 1991\nRevenues: Interest income from subsidiaries* $ 1,090 $ 1,835 $ 1,209 Other investment income 62 15 243 Dividends from consolidated subsidiaries* 10,345 10,482 15,672 11,497 12,332 17,124\nExpenses: Operating and administrative expenses 4,702 2,154 1,681 Interest expense 3,204 2,206 2,893 7,906 4,360 4,574\nIncome before equity in undistributed net income or loss of subsidiaries 3,591 7,972 12,550\nEquity in undistributed net income (loss) of subsidiaries* 8,554 (24,931) (3,678)\nNet income (loss) 12,145 (16,959) 8,872\nPreferred stock dividends 2,021 2,039 2,039\nIncome (loss) applicable to common stockholders $ 10,124 $(18,998) $ 6,833\nSee note to condensed financial statements.\n*Eliminated in consolidation.\nSCHEDULE III\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT--Continued\nCONDENSED STATEMENTS OF CASH FLOWS (In thousands)\nYear Ended December 31 1993 1992 1991\nOPERATING ACTIVITIES Net income (loss) $ 12,145 $(16,959) $ 8,872 Adjustments to reconcile net income or loss to net cash provided by operating activities: Change in other assets and liabilities 1,678 (929) 4,289 Equity in undistributed net (income) loss of subsidiaries* (8,554) 24,931 3,678\nNET CASH PROVIDED BY OPERATING ACTIVITIES 5,269 7,043 16,839\nINVESTING ACTIVITIES Additional investment in consolidated subsidiaries* (15,219) (13) (83)\nFINANCING ACTIVITIES Decrease (increase) in notes receivable from PLIC 29,128 (11,597) (1,012) Increase in notes receivable from UGH (37,495) - - Net proceeds from issuance of convertible subordinated debentures 54,055 - - Increase in notes payable - 10,000 - Repayment of notes payable (31,600) (3,900) (13,000) Decrease (increase) in other notes receivable from subsidiaries* 3,591 (447) (218) Stock options exercised 451 165 - Dividends paid (2,021) (2,039) (2,039) Purchase of treasury stock (4,720) (52) - Retirement of preferred stock (315) - - Other 44 717 -\nNET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 11,118 (7,153) (16,269)\nINCREASE (DECREASE) IN CASH 1,168 (123) 487\nCASH AT BEGINNING OF YEAR 543 666 179\nCASH AT END OF YEAR $ 1,711 $ 543 $ 666\nSee note to condensed financial statements. *Eliminated in consolidation.\nSCHEDULE III\nPIONEER FINANCIAL SERVICES, INC. (Parent Company)\nNOTE TO CONDENSED FINANCIAL STATEMENTS\nThe accompanying condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto of Pioneer Financial Services, Inc.\nAt December 31, 1992, the notes receivable from Pioneer Life Insurance Company of Illinois (\"PLIC\") represented $15,000,000 and $10,000,000 in surplus debentures and $4,128,000 of accrued interest. The interest rate on the $15,000,000 surplus debenture was 6.75% through June 30, 1992 and was 7% thereafter. The interest rate on the $10,000,000 surplus debenture was 7%. The payment of principal and interest to the parent company from PLIC requires regulatory approval. The surplus debentures were repaid in the third quarter of 1993.\nAt December 31, 1993, the notes receivable from United Group Holdings of Delaware (UGH) represents the purchase of National Group Life Insurance Company from the parent company. The note bears interest at the rate of 8% and matures on December 31, 1998.\nSCHEDULE V\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION (In thousands)\nDecember 31\nDeferred Future Policy Policy Benefits and Acquisition Policy and Unearned Other Policy Segment Costs Contract Claims Premiums Liabilities\n1993: Insurance: Accident and health $203,861 $341,916 $ 87,945 $ 8,066\nLife and annuity 56,571 458,207 - 6,971\nMarketing - - - -\nManaged care - - - - $260,432 $800,123 $ 87,945 $ 15,037\n1992: Insurance: Accident and health $215,157 $288,966 $ 90,880 $ 2,832\nLife and annuity 54,517 417,590 - 5,428\nMarketing - - - -\nManaged care - - - - $269,674 $706,556 $ 90,880 $ 8,260\n1991: Insurance: Accident and health $257,695 $266,430 $ 99,748 $ 2,075\nLife and annuity 55,758 404,189 - 4,129\nMarketing - - - -\nManaged care - - - - $313,453 $670,619 $ 99,748 $ 6,204\nSCHEDULE V (continued)\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION (In thousands)\nSCHEDULE VI\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nREINSURANCE (In thousands)\nAssumed Percentage Ceded to from of Amount Gross Other Other Net Assumed Amount Companies Companies Amount to net\nYear Ended December 31, 1993: Life insurance in force* $11,823,127$3,859,945 $ - $7,963,182 -\nPremiums and Policy Charges: Insurance: Accident and health $ 606,788$ 24,154 $ 19,050$ 601,684 3.2% Life and annuity 60,028 16,438 288 43,878 .7 Marketing - - - - - Managed care - - - - - $ 666,816$ 40,592 $ 19,338$ 645,562 3.9%\nYear Ended December 31, 1992: Life insurance in force* $10,338,557$3,929,621 $ - $6,408,936 -\nPremiums and Policy Charges: Insurance: Accident and health $ 558,847$ 14,328 $ 15,375$ 559,894 2.7% Life and annuity 51,332 16,141 28 35,219 .1 Marketing - - - - - Managed care - - - - - $ 610,179$ 30,469 $ 15,403$ 595,113 2.8%\nYear Ended December 31, 1991: Life insurance in force* $ 9,140,882$4,579,278 $ - $4,561,604 -\nPremiums and Policy Charges: Insurance: Accident and health $ 597,046$ 17,726 $ 13,916$ 593,236 2.3% Life and annuity 49,367 16,063 17 33,321 .1 Marketing - - - - - Managed care - - - - - $ 646,413$ 33,789 $ 13,933$ 626,557 2.4%\n*At end of year\nSCHEDULE VIII\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\n(In thousands)\nDeductions- Doubtful Accounts Written Balance at Additions- off During Balance Beginning Charged to the Year at End of Year Expense /Disposals of Year\nDescription\nYear Ended December 31, 1993: Allowance for doubtful accounts $1,504 $1,171 $1,404 $1,271 Accumulated depreciation on building and equipment 11,646 5,515 270 16,891\nYear Ended December 31, 1992: Allowance for doubtful accounts 147 1,475 118 1,504 Accumulated depreciation on building and equipment 9,122 3,245 721 11,646\nYear Ended December 31, 1991: Allowance for doubtful accounts 40 147 40 147 Accumulated depreciation on building and equipment 6,488 2,844 210 9,122\nSCHEDULE IX\nPIONEER FINANCIAL SERVICES, INC. AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\n(Dollars in thousands)\n* Bank borrowing represents short term arrangements generally at prime rates. These amounts exclude current portion of long-term notes payable.\n** The average amounts outstanding during the year were computed based on the month-end principal balances.\n*** The weighted average interest rates during the year were computed by dividing the actual interest expense by average short-term debt outstanding.\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPIONEER FINANCIAL SERVICES, INC.\nBY: /S/ Peter W. Nauert\nPeter W. Nauert, Chairman/President\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: March 30, 1993\n/S/ Peter W. Nauert /S/ Michael A. Cavataio\nPeter W. Nauert, Chairman, Michael A. Cavataio Chief Executive Officer, and Director Director\n/S/ William B. Van Vleet /S/ Nolanda S. Hill\nWilliam B. Van Vleet, Executive Nolanda S. Hill Vice President and Director Director\n/S/ David I. Vickers /S/ Karl-Heinz Klaeser\nDavid I. Vickers, Treasurer Karl-Heinz Klaeser and Chief Financial Officer Director\n/S/ Robert F. Nauert /S/ Richard R. Haldeman\nRobert F. Nauert Richard R. Haldeman Director Director\n/S/ Michael K. Keefe\nMichael K. Keefe Director\nIndex to Exhibits\nExhibit Sequentially Number Description of Document Numbered Page\n3 (a) Certificate of Incorporation of the Company (filed as Exhibit 3(a) to the Company's Registration Statement on Form S-1 [No. 33-7759] and incorporated herein by reference)\n3 (b) Amended Bylaws of the Company (filed as Exhibit 3(b) to Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (a) Certificate of Designations with respect to the Company's $2.125 Cumulative Convertible Exchangeable Preferred Stock (\"Preferred Stock\") (filed as Exhibit 4(a) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (b) Proposed form of Indenture with respect to the Company's 8 1/2% Convertible Subordinated Debentures due 2014 into which the Preferred Stock is exchangeable (filed as Exhibit 4(b) to Post-Effective Amendment No. 1 to the Company's Registration Statement on Form S-1 [No. 33-30017] and incorporated herein by reference)\n4 (c) Rights Agreement dated as of December 12, 1990 between the Company and First Chicago Trust Company of New York as Rights Agent (including exhibits thereto) (filed as Exhibit 1 to the Company's registration statement on Form 8-A dated December 14, 1990 and incorporated herein by reference)\n10 (a) Form of contract with independent agents (filed as Exhibit 10(f) to the Company's Registration Statement on Form S-1 [No. 33-7759] and incorporated herein by reference)\n10 (b) Nonqualified Stock Option Plan (filed as Exhibit 10(g) to the Company's Registration Statement on Form S-1 [No. 33-7759] and\nincorporated herein by reference)\n10 (c) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(d) to the Company's Registration Statement on Form S-8 [No. 33-26455] and incorporated herein by reference)\n10 (d) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(c) to the Company's Registration Statement on Form S-1 [No. 33-17011] and incorporated herein by reference)\n10 (e) Amendment to the Nonqualified Stock Option Plan of the Company (filed as Exhibit 10(e) to the Company's registration statement on Form S-8 [No. 33-37305] and incorporated herein by reference)\n10 (f) Amended and Restated Receivables purchase agreement dated as of October 1, 1992 by and between Design Benefit Plans, Inc. (formerly National Group Marketing Corporation) and National Funding Corporation (filed herewith)\n*10 (g) Employment Agreement dated December 3, 1993 by and between the Company and Peter W. Nauert\n10 (h) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and Pioneer Life Insurance Company of Illinois (filed as Exhibit 10(v) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n10 (i) Administrative Service Agreement dated December 23, 1991, by and between Administrative Service Corporation and National Group Life (filed as Exhibit 10(w) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n*10 (j) Employment Agreement dated December 31, 1991 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed as Exhibit 10(x) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference)\n*10 (k) Amendment to Employment Agreement dated\nMarch 26, 1993 by and between National Benefit Plans, Inc. and Peter W. Nauert (filed herewith)\n*10 (l) Employment Agreement dated December 31, 1991 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed as Exhibit 10(y) to the Company's Annual Report on Form 10-K [No. 0-14977] and incorporated herein by reference) *10 (m) Amendment to Employment Agreement dated March 26, 1993 by and between Direct Financial Services, Inc. and Peter W. Nauert (filed herewith)\n10 (n) Credit Agreement dated as of December 22, 1993 by and among the Company and American National Bank and Trust Company of Chicago, as Agent and American National Bank and Trust Company of Chicago, Firstar Bank Milwaukee, N.A. and Bank One, Rockford, NA, as Banks\n11 Statement of Computation of per share net income or loss . . . . . . . . . . . . . . . . . __\n21 List of subsidiaries . . . . . . . . . . . __\n23 Consent of Ernst & Young . . . . . . . . . __\nExhibit 10(g)\nEMPLOYMENT AGREEMENT\nThis Agreement is made this December 3, 1993, by and between PIONEER FINANCIAL SERVICES, INC., a Delaware corporation, having its principal place of business at 304 N. Main Street, Rockford, Illinois, 61101 (hereinafter \"Pioneer Financial\"); and PETER W. NAUERT, an individual residing at 5019 Parliament Place, Rockford, Illinois 61107.\nW I T N E S S E T H:\nWHEREAS, Pioneer Financial is an insurance holding company which has life insurance subsidiaries and affiliated administrative service and marketing companies; and\nWHEREAS, Nauert is current Chairman and Chief Executive Officer of Pioneer Financial and Nauert possesses valuable skills, expertise and abilities in the life and accident and health insurance business; and\nWHEREAS, Pioneer Financial is desirous of retaining the services of Nauert as a key managerial employee; and\nWHEREAS, Nauert desires to be employed by Pioneer Financial on the terms set forth herein:\nNOW, THEREFORE, for and in consideration of the covenants contained herein, Pioneer Financial hereby employs Nauert and Nauert accepts such employment with Pioneer Financial upon the terms and conditions hereinafter set forth.\n1. Employment. Pioneer Financial hereby employs Nauert and Nauert hereby agrees to be employed by Pioneer Financial for a term of three (3) calendar years commencing on the first day of January, 1994, and continuing through the 31st day of December, 1996 and for successive three- year periods thereafter until terminated as provided herein, to perform the duties set forth herein.\n2. Duties. Subject to the control of the Board of Directors of Pioneer Financial, Nauert shall serve during the Term as Chairman and Chief Executive Officer of Pioneer Financial and in such capacity shall render such services as the Board of Directors of Pioneer Financial shall direct. In addition, Nauert shall serve in such other offices or capacities as the Board of Directors of Pioneer Financial may from time to time determine. Nauert shall have such executive powers and authority as may reasonably be required by him in order to discharge such duties in an efficient and proper manner.\n3. Compensation. Pioneer Financial shall in the aggregate pay to Nauert for all services to be rendered hereunder:\n(a) an annual salary in the amount of $600,000; provided that the Board of Directors of Pioneer Financial shall annually make a review of Nauert's salary and increase such annual salary as it deems appropriate; and\n(b) an annual bonus, as determined by the compensation committee of the Board of Directors of Pioneer Financial, based upon achieving the Pioneer Financial's company-wide performance standards as established by such committee.\n4. Loan. As further compensation to Nauert for his employment hereunder, Pioneer Financial agrees to make available to Nauert at any time prior to June 30, 1994, a three-year term loan not in excess of $1,300,000 of principal indebtedness at an annual rate of interest of 3.71% payable annually, said loan to provide Nauert forgiveness not in excess of 50% of the initial principal indebtedness dependent on PFSI's attaining, as of 12/31/96, either of the following specified performance goals of PFSI's compensation committee:\nSpecified 12/31/96 Amount of Loan PFSI Performance Goals Forgiveness at 12/31/96\nCumulative, fully diluted $325,000, loan PFSI GAAP net income per forgiveness common share (\"Cumulative EPS\") from 1/1/94 through 12/31/96, inclusive, of $4.50 Cumulative EPS from From Cumulative EPS (but 1/1/94 through 12/31/96, not to exceed $7.50) inclusive, greater than subtract $4.50, divide $4.50 the result by $3.00 and multiply the resulting quotient by $975,000. Add the amount so produced to $325,000 to arrive at loan forgiveness.\nSaid loan shall be evidenced by a Note in a form substantially similar to Exhibit \"A\" hereto.\n5. Benefits. During his employment hereunder, Nauert shall be entitled to participate in all employee benefits made available to management personnel of Pioneer Financial and its subsidiaries.\n6. Death. Nauert's employment by Pioneer Financial will terminate immediately upon his death. No compensation for any period after Nauert's death will be payable to Nauert's estate.\n7. Disability. If during Nauert's employment hereunder, Nauert\nbecomes totally or partially disabled, Pioneer Financial shall continue to pay to Nauert as long as such disability continues during the Term (or until Nauert's employment is terminated by Pioneer Financial in accordance with Section 8 (if earlier)) the level of annual salary payable to Nauert at the date his disability is determined, reduced dollar-for-dollar to the extent of any disability insurance payments paid to Nauert through insurance programs, the premiums for which were paid by Pioneer Financial or its Subsidiaries or affiliates. For purposes of this Agreement, the term \"total disability\" shall mean Nauert's inability due to illness, accident or other physical or mental incapacity to engage in the full time performance of his duties under this Agreement as reasonably determined by the Board of Directors of Pioneer Financial based on such evidence as such Board shall deem appropriate. For purposes of this Agreement, \"partial disability\" shall mean Nauert's ability due to illness, accident or other physical or mental incapacity to engage in only the partial performance of his duties under this Agreement, as reasonably determined by the Board of Directors of Pioneer Financial based on such evidence as such Board shall deem appropriate.\n8. Termination.\n(a) For Cause. Pioneer Financial shall have the right to terminate Nauert's employment hereunder at any time during the Term \"for cause\". For purposes of this Agreement, \"for cause\" shall mean any of the following actions (or inactions) by Nauert: illegal conduct of a severity greater than a misdemeanor, gross neglect of, and the continued failure to perform substantially, Nauert's duties under this Agreement. Notwithstanding anything herein to the contrary, Nauert's inability to perform the duties of his position due to his total or partial disability (as defined herein) shall not be deemed to constitute cause.\nIf, in the opinion of the Board of Directors of Pioneer Financial, Nauert's employment shall become subject to termination for cause, such Board of Directors shall give Nauert notice to that effect, which notice shall describe the matter or matters constituting such cause. Thereafter, for a period of thirty (30) days from the receipt of such notice, Nauert shall have the opportunity to eliminate or cure the matter or matters constituting such cause. If at the end of such thirty (30) day period, Nauert has not substantially eliminated or cured each such matter or matters, then Pioneer Financial shall have the right to give Nauert notice of the termination of his employment. Nauert's employment hereunder shall be considered terminated for cause as of the date specified in such notice of termination unless and until there is a final determination by a court of competent jurisdiction that the cause of termination of Nauert's employment did not exist at the time of giving said notice of termination. Upon termination of Nauert's employment \"for cause,\" this Agreement shall terminate without further obligations to Nauert other than Pioneer Financial's obligation (a) to pay to Nauert in a lump sum in cash within 30 days after the date of termination Nauert's base salary through the date of termination to the extent not theretofore paid and (b) to the extent not theretofore paid or provided, to pay or provide, to Nauert on a timely basis any other amounts or benefits required to be paid or provided or\nwhich Nauert is eligible to receive under any plan, program, policy or practice or contract or agreement of Pioneer Financial.\n(b) Without Cause. Pioneer Financial shall have the right to terminate Nauert's employment hereunder without cause at any time during the Term. If the Board of Directors determines to terminate Nauert's employment without cause, Pioneer Financial shall give notice of the termination to Nauert and Nauert's employment hereunder shall be considered terminated without cause as of the date specified in such notice of termination. Upon the date of the termination of Nauert's employment without cause, Nauert shall be paid an amount equal to the present value, discounted to the present at an annual rate of 8%, of the salary which would have been payable during a period of twenty-four (24) months commencing on the date of termination at the level of annual salary payable to Nauert at the date of termination.\n(c) By Nauert. Nauert may terminate his employment hereunder at any time by retirement or resignation, upon notice to Pioneer Financial. Upon such termination by Nauert, no compensation for any period after the date of such termination shall be payable to Nauert; provided, however, that if such termination by Nauert is for \"good reason\" (as defined in Section 9(c)), then Nauert shall be entitled to the payment described in the last sentence of Section 8(b).\n(d) Change in Control Effect. No payments shall be made to Nauert pursuant to this Section 8 in the event that Nauert is entitled to Change in Control Compensation pursuant to Section 9.\n9. Change in Control.\n(a) Change in Control Severance Compensation. If, within two years following a \"change in control\", Nauert's employment is terminated by Pioneer Financial other than \"for cause\" (as defined in Section 8(a)) or is terminated by Nauert for \"good reason\" (as defined in Section 9(c)), Nauert shall be entitled to receive from Pioneer Financial a lump sum cash payment in an amount equal to three times his annual salary for the year in which such termination occurs (\"Change in Control Compensation\"). Pioneer Financial shall pay such amount to Nauert within ten (10) days of the date of termination. If Nauert's employment is terminated by Pioneer Financial for cause, by reason of Nauert's death or retirement, or by Nauert without good reason, the Change in Control Compensation will not be paid. If Nauert was totally or partially disabled as of the Change in Control, the Change in Control Compensation will not be paid.\n(b) Change in Control. For purposes of this Agreement, \"Change in Control\" shall mean the occurrence of any of the following events:\n(i) any person or persons acting as a group, other than a person which as of the date of this Agreement is the beneficial owner of voting securities of Pioneer Financial and other than Nauert or a group including Nauert, shall become the beneficial owner of securities of Pioneer Financial representing at least\ntwenty percent (20%) of the combined voting power of Pioneer Financial's then outstanding securities; or\n(ii) any consolidation or merger to which Pioneer Financial is a party, if following such consolidation or merger, stockholders of Pioneer Financial immediately prior to such consolidation or merger shall not beneficially own securities representing at least eighty-one percent (81%) of the combined voting power of the outstanding voting securities of the surviving or continuing corporation; or\n(iii) any sale, lease, exchange or other transfer (in one transaction or in a series of related transactions) of all, or substantially all, of the assets of Pioneer Financial, other than to an entity (or entities) of which Pioneer Financial or the stockholders of Pioneer Financial immediately prior to such transactions beneficially own securities representing at least eighty-one percent (81%) of the combined voting power of the outstanding voting securities.\n(c) Good Reason. For purposes of this Agreement, \"good reason\" shall mean any of the following:\n(i) the assignment to Nauert of any duties or responsibilities which are inconsistent with Nauert's status and position in effect immediately prior to the Change in Control, or a reduction in the duties and responsibilities exercised by Nauert immediately prior to the Change in Control;\n(ii) any action by Pioneer Financial which renders Nauert unable to effectively discharge the duties and responsibilities exercised by Nauert immediately prior to the Change in Control;\n(iii) a reduction in Nauert's level of annual salary as in effect immediately prior to the Change in Control or failure to maintain Nauert's minimum annual salary in accordance with Section 3(a);\n(iv) a failure by Pioneer Financial to continue in effect, without material change, any benefit or incentive plan or arrangement in which Nauert participated immediately prior to the Change in Control, or the taking of any action by Pioneer Financial which would materially and adversely affect Nauert's participation in or materially reduce Nauert's benefits under any such plan or arrangement;\n(v) a relocation of Nauert's workplace by Pioneer Financial to any place more than twenty-five (25) miles from the location at which Nauert performed his duties immediately prior to the Change in Control, except for required travel by Nauert on Pioneer Financial's business to an extent substantially consistent with Nauert's business travel obligations immediately\nprior to the Change in Control;\n(vi) a failure by Pioneer Financial to provide to Nauert paid vacation benefits on the basis and to extent provided immediately prior to the Change in Control; or\n(vii) any failure by Pioneer Financial to obtain the assumption of this Agreement by any successor or assignee thereto.\n(d) Gross-Up. In the event that any payment received or to be received by Nauert in connection with a Change in Control of Pioneer Financial or the termination of Nauert's employment (whether payable pursuant to the terms of this Agreement or any other plan, arrangement or agreement with Pioneer Financial or any person whose actions result in a Change in Control of Pioneer Financial or any person affiliated with Pioneer Financial or such person (the \"Change in Control Payments\") will be subject to the tax (the \"Excise Tax\") imposed by Section 4999 of the Internal Revenue Code, as amended (the \"Code\"), Pioneer Financial shall pay to Nauert, upon payment of the Change in Control Compensation, an additional amount (the \"Gross-Up Payment\") such that the net amount retained by Nauert, after deduction of any Excise Tax on the Change in Control Payments and any federal and state and local income tax and Excise Tax upon the Gross-Up Payment, shall be equal to the Change in Control Payments. For purposes of determining whether any of the Change in Control Payments will be subject to the Excise Tax and the amount of such Excise Tax, any Change in Control Payments shall be treated as a \"parachute payment\" within the meaning of Section 280G(b)(2) of the Code, and all \"parachute payments\" in excess of the \"base amount\" within the meaning of Section 280G(b)(3) of the Code shall be treated as subject to the Excise Tax, unless in the opinion of tax counsel selected by Pioneer Financial and acceptable to Nauert such Change in Control Payments (in whole or in part) do not constitute parachute payments, or such parachute payments in excess of the base amount (in whole or in part) are otherwise not subject to the Excise Tax. For purposes of determining the amount of the Gross-Up Payment, Nauert shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar year in which the Gross-Up Payment is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of his residence on the date of termination, net of the maximum reduction in federal income taxes which could be obtained from deduction of such state and local taxes. In the event that the Excise Tax is subsequently determined to be less than the amount originally taken into account hereunder Nauert shall repay to Pioneer Financial at the time that the amount of such reduction in Excise Tax is finally determined, the portion of the Gross-Up Payment attributable to such reduction plus interest on the amount of such repayment at the rate provided in Section 1274(b)(2)(B) of the Code. In the event that the Excise Tax is determined to exceed the amount originally taken into account hereunder, Pioneer Financial shall make an additional Gross-Up Payment in respect of such excess at the time that the amount of such excess is finally determined. Nauert shall notify Pioneer Financial of any audit or review by the Internal Revenue Service of\nNauert's federal income tax return for the year in which a Change in Control Payment or Gross-Up Payment under this Agreement is made within ten (10) days of Nauert's receipt of notification of such audit or review. In addition, Nauert shall also notify Pioneer Financial of the final resolution of such audit or review within ten (10) days of such resolution.\n10. Confidential Information and Trade Secrets.\n(a) Nature. During Nauert's employment by Pioneer Financial, Nauert will enjoy access to Pioneer Financial's \"confidential information\" and \"trade secrets\". For purposes of this Agreement, \"confidential information\" shall mean information which is not publicly available, including without limitation, information concerning customers, material sources, suppliers, financial projections, marketing plans and operation methods, Nauert's access to which derives solely from Nauert's employment with Pioneer Financial. For purposes of this Agreement, \"trade secrets\" shall mean Pioneer Financial's processes, methodologies and techniques known only to those employees of Pioneer Financial who need to know such secrets in order to perform their duties on behalf of Pioneer Financial. Pioneer Financial take numerous steps, including these provisions, to protect the confidentiality of its confidential information and trade secrets, which it considers unique, valuable and special assets.\n(b) Restricted Use and Non-Disclosure. Nauert, recognizing Pioneer Financial's significant investment of time, efforts, and money in developing and preserving its confidential information, shall not, during his employment hereunder and for a two (2) year period after the end of Nauert's employment hereunder, use for his direct or indirect personal benefit any of Pioneer Financial's confidential information or trade secrets. For a two (2) year period after the end of Nauert's employment hereunder, Nauert shall not disclose to any person any of Pioneer Financial's confidential information or trade secrets.\n(c) Return of Pioneer Financial Property. Upon termination of Nauert's employment with Pioneer Financial, for whatever reason and in whatever manner Nauert shall return to Pioneer Financial all copies of all writings and records relating to Pioneer Financial's business, confidential information or trade secrets, which are in Nauert's possession at such time.\n11. Non-Competition and Non-Solicitation.\n(a) Pioneer's Financial Investment. Pioneer Financial is spending and will spend much time, money and effort in building relationships with agents and insureds, and will pay Nauert valuable consideration pursuant hereto in exchange for Nauert's promises herein, including without limitation the covenants in Section 10 and in this Section 11. Pioneer Financial has engaged Nauert as Chairman and Chief Executive Officer of Pioneer Financial in order to, among other reasons, take advantage of Nauert's unique knowledge of, and contacts within, the life and accident and health insurance industry. Further, Pioneer Financial will invest significant time and money in the further development\nof Nauert's business ability, image and standing. As Nauert is Chairman and Chief Executive Officer of Pioneer Financial, the reputation and success of Nauert will be closely tied to the reputation and success of Pioneer Financial and, during the Term, Nauert will be heavily identified with Pioneer Financial's business.\n(b) Non-Competition. During Nauert's employment hereunder and for a twelve (12) month period after termination of such employment, unless such termination is made by Pioneer Financial without cause or unless there has been a Change in Control prior to such termination, Nauert shall not engage, directly or indirectly, whether as an owner, partner, employee, officer, director, agent, consultant or otherwise, in any location where Pioneer Financial or any of its subsidiaries is engaged in business after the date hereof and prior to the termination of Nauert's employment, in a business the same as, or similar to, any business now, or at any time after the date hereof and prior to Nauert's termination, conducted by Pioneer Financial or any of its subsidiaries, provided, however, that the mere ownership of 5% or less of the stock of a company whose shares are traded on a national securities exchange or are quoted on the National Association of Securities Dealers Automated Quotation System shall not be deemed ownership which is prohibited hereunder.\n(c) Non-Solicitation. During the twenty-four (24) month period following termination of Nauert's employment with Pioneer Financial, Nauert shall not, directly or indirectly induce employees of Pioneer Financial or any of its subsidiaries to leave such employment with the result that such employees would engage in business activities which are substantially similar or are closely related to the business activities such employee performed on behalf of Pioneer Financial and which compete against Pioneer Financial. Notwithstanding the above, in the event Nauert is terminated by Pioneer Financial without cause, then the twenty-four (24) month period referred to in this Section 11(c) shall be reduced to twelve (12) months.\n(d) Enforceability. The necessity of protection against the competition of Nauert and the nature and scope of such protection has been carefully considered by the parties hereto. The parties hereto agree and acknowledge that the duration, scope and geographic areas applicable to the non-competition covenant in this Section 11 are fair, reasonable and necessary, that adequate compensation has been received by Nauert for such obligations, and that these obligations do not prevent Nauert from earning a livelihood. If, however for any reason any court determines that the restrictions in this Agreement are not reasonable, that consideration is inadequate or that Nauert has been prevented from earning a livelihood, such restrictions shall be interpreted, modified or rewritten to include as much of the duration, scope and geographic area identified in this Section 11 as will render such restrictions valid and enforceable.\n12. Retention of PFSI Stock. During the Term, Nauert shall retain, directly or indirectly, ownership of not less than 1,000,000 shares of PFSI Common Stock unless, and except to the extent, released from this obligation by a written release from Pioneer Financial. For purposes of this Agreement, \"retain indirectly\" shall mean and refer to any shares of\nPFSI Common Stock, which would be considered to be owned by Nauert under Section 267(c), or the income of which would be taxable to Nauert, his spouse or his children, or to any trust of which Nauert would be deemed the owner under any of Sections 671 through 677, inclusive, of the Internal Revenue Code of 1986.\n13. Rights of First Refusal. During the Term, Nauert shall not transfer any shares of stock of Pioneer Financial for consideration to any person other than a relative of Nauert, unless Nauert has offered to transfer such shares to Pioneer Financial on the same terms, provided, however, that this provision shall not apply at any time when the average last reported sale price for Common Stock of Pioneer Financial on the New York Stock Exchange for the immediately preceding five trading days is greater than or equal to $12.00 per share.\n14. Related Company Agreements and Options. Parties hereto recognize that Pioneer Financial has a number of related companies and that Nauert currently has employment agreements with two such companies, namely, Direct Financial Services, Inc. and National Benefit Plans, Inc. This agreement in no way supersedes or modifies any of the terms, undertaking, responsibilities or rights of any of the parties to said employment agreements. Notwithstanding the foregoing, and in consideration of Pioneer Financial's execution of this Agreement, Nauert agrees to forego his right to certain bonuses equal to 10% of net income under his current employment agreements with Pioneer Financial's subsidiaries National Benefit Plans, Inc. and Direct Financial Services, Inc.\n15. Breach or Threatened Breach of Non-Competition Covenant. In the event of a breach or threatened breach by Nauert of any provision of Section 10 or 11 hereof, Nauert acknowledges that the remedy at law would be inadequate and that Pioneer Financial shall be entitled to an injunction restraining Nauert from such act or threatened breach. Nothing herein contained shall be construed as prohibiting Pioneer Financial from pursuing any other remedies available to it for such breach or threatened breach, including the recovery of monetary damages.\n16. Business Days. Any date specified in this Agreement which is a Saturday, Sunday or legal holiday shall be extended to the first regular business day after such date which is not a Saturday, Sunday or legal holiday.\n17. Choice of Law. This Agreement has been executed and made in accordance with the laws of the State of Illinois and is to be construed, enforced and governed in accordance therewith.\n18. Counterparts. This Agreement may be executed in several counterparts, each of which shall be an original, but all of which together shall constitute one and the same instrument.\n19. Entire Agreement Amendments. This Agreement contains the entire agreement among the parties hereto with respect to the subject matter hereof. No change or modification of this Agreement, or any waiver\nof the provisions hereof, shall be valid unless same is in writing and signed by the parties hereto. Waiver by any party hereto of a breach by the other party of any provisions of this Agreement shall not operate or be construed as a waiver of any subsequent breach by such party.\n20. Headings. The headings used herein are for each of interpretation and shall have no effect on the interpretation of any provision of this Agreement.\n21. Notices. All notices, requests, demands and other communications hereunder shall be in writing and shall, until receipt of contrary written instructions, be delivered personally to, or mailed by certified or registered mail with proper postage prepaid, to the party at the address as follows:\nTo Pioneer Financial:\nPioneer Financial Services, Inc. 304 N. Main Street Rockford, Illinois 61101\nTo Nauert:\nMr. Peter W. Nauert 5019 Parliament Place Rockford, Illinois 61107\n22. Severability. If any provision of this Agreement is held for any reason to be invalid, it will not invalidate any other provisions of this Agreement which are in themselves valid, nor will it invalidate the provisions of any other agreement between the parties hereto. Rather, such invalid provision shall be construed so as to give it the maximum effect allowed by applicable law. Any other written agreement between the parties hereto shall be conclusively deemed to be an agreement independent of this Agreement.\n23. Successors and Assigns. This Agreement and all the provisions hereof shall be binding upon and inure to the benefit of the parties hereto and their respective heirs, legal representatives, successors and permitted assigns. This Agreement and the rights and obligations hereunder may not be assigned by either party without the prior written consent of the other.\n24. Time of the Essence. Time is of the essence of this Agreement.\nIN WITNESS WHEREOF, the parties hereto have caused this Employment Agreement to be executed on the date first above written.\nAttest: \"Pioneer Financial\"\nPIONEER FINANCIAL SERVICES, INC.\n/s/ Chuck R. Scheper By: /s/ Karl-Heinz Klaeser Title: Chairman - Compensation Committee\nWitness: \"Nauert\"\n/s/ Philip J. Urbanek /s/ Peter W. Nauert Peter W. Nauert\nEXHIBIT A\n$1,300,000 Rockford, Illinois January 1, 1994\nNON-NEGOTIABLE PROMISSORY NOTE ______________________________\nFor value received, PETER W. NAUERT (\"Nauert\") hereby promises to pay to PIONEER FINANCIAL SERVICES, INC., a Delaware corporation (\"PFSI\"), at its principal office at 304 N. Main Street, Rockford, Illinois or such other address as the holder hereof may designate, the sum of One Million, Three Hundred Thousand and No/One Hundredths Dollars ($1,300,000.00). Payment shall be made in a single payment on the last day of December, 1996. In addition, on the 31st day of December, 1994, 1995 and 1996, Nauert shall pay PFSI interest at the rate of 3.71 percent per annum on the principal balance outstanding from time to time computed from the date hereof until paid.\nThis Note is the note referred to in, and is being issued to Nauert by PFSI in accordance with Paragraph 14 of that certain Employment Agreement dated __________, 1993 by and between Nauert and PFSI, and is subject thereto.\nAny payment due under this Note may be prepaid in whole or in part at any time and from time to time before its payments date. Any such prepayment shall be first applied against the principal amount of this Note and then against interest accrued thereon.\nNotwithstanding the foregoing, in the event either of the following specified performance goals of PFSI's compensation committee is achieved, the initial principal indebtedness of $1,300,000 shall be forgiven as of 12/31/96 as follow:\nSpecified 12/31/96 Amount of Loan PFSI Performance Goals Forgiveness at 12/31/96 ______________________ _______________________\nCumulative, fully diluted $325,000, loan PFSI GAAP net income per forgiveness common share (\"Cumulative EPS\") from 1/1/94 through 12/31/96, inclusive, of $4.50\nSpecified 12/31/96 Amount of Loan PFSI Performance Goals Forgiveness at 12/31/96 ______________________ _______________________\nCumulative EPS from From Cumulative EPS (but 1/1/94 through 12/31/96, not to exceed $7.50) inclusive, greater than subtract $4.50, divide $4.50 the result by $3.00 and multiply the resulting quotient by $975,000. Add the amount so produced to $325,000 to arrive at loan forgiveness.\nIn the event that PFSI's GAAP financial results as of 12/31/96 are not determinable with reasonable accuracy on 12/31/96, or even upon the due date of this Notice if such date is after 12/31/96, the PFSI's compensation committee may estimate the amount of forgiveness for purposes of Nauert's timely payoff of this Note, less the forgiveness. In such event, not later than June 30, 1997, PFSI's compensation committee shall obtain certified GAAP financial results for PFSI as of 12/31/96 and submit such certified financial results to Nauert. At such time, the difference between the amount of forgiveness previously estimated and allowed Nauert at the time of this Note's repayment and the amount of such forgiveness indicated by said certified financial results shall be reimbursed by PFSI to Nauert, or paid by Nauert to PFSI, as the case may be, together with interest thereon at the rate of 8% per annum from the date of this Note's repayment to the date of said reimbursement, or payment, as the case may be.\nThe following shall be deemed events of default hereunder: (a) failure by Nauert to make any payment hereunder within five (5) business days of the due date of such payment; (b) the filing by Nauert of a voluntary petition, or the filing against Nauert of an involuntary petition which is not dismissed within sixty (60) days, under the provisions of Title 11 of the United State Code or any state insolvency law; (c) application for or appointment of a receiver for Nauert; (d) issuance of a warrant of attachment or writ of execution against Nauert or his property; (e) any assignment by Nauert for the benefit of his creditors; or (f) termination by Nauert of his employment under the above referenced Employment Agreement, except for \"good reason\" (as defined in Section 9(c) of said Employment Agreement). Upon the occurrence of an event of default hereunder, the holder may, at his option, declare the entire unpaid balance of the principal hereunder, together with interest thereon, immediately due and payable by delivering to Nauert written notice of such effect.\nNauert hereby waives presentment for payment, notice of dishonor, protest or diligence in bringing suit hereon. In the event any payments herein provided for shall not be made at the time they shall become due, Nauert shall reimburse the holder hereof for all costs of collection and for reasonable attorneys' fees incurred to obtain such payments.\nThis Note shall be construed in accordance with and governed in all respects by the laws and decisions of the State of Illinois.\n/s/ Peter W. Nauert Peter W. Nauert\nExhibit 10(n)\nCREDIT AGREEMENT\nDated as of December 22, 1993\namong\nPIONEER FINANCIAL SERVICES, INC.,\nAMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO, as Agent\nand\nAMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO,\nFIRSTAR BANK MILWAUKEE, N.A.\nand\nBANK ONE, ROCKFORD, NA\nPage\nSECTION 1 CERTAIN DEFINITIONS . . . . . . . . . . . . . . 1 SECTION 1.1 Terms Defined in this Agreement . . . . . . . . . . 1\nSECTION 2 BANK'S COMMITMENT; BORROWING PROCEDURES; LCs . . . . . . . 11 SECTION 2.1 Bank's Commitment to Make Loans . . . . . . . . . . 11 SECTION 2.3 Procedure for Borrowing . . . . . . . . . . . . . . 12 SECTION 2.4 Conversion and Continuation Elections. . . . . . . 13 SECTION 2.5 LC Documentation. . . . . . . . . . . . . . . . . . 15 SECTION 2.6 Agreement to Repay LC Drawings. . . . . . . . . . . 17 SECTION 2.6A Participations. . . . . . . . . . . . . . . . . . . 17 SECTION 2.7 Mandatory Payment of LC Liability. . . . . . . . . 20 SECTION 2.8 LC Operations. . . . . . . . . . . . . . . . . . . 20 SECTION 2.9 Voluntary Termination or Reduction of Commitments. . . . . . . . . . . . . . . . . . . . . . . . . 21 SECTION 2.11 Mandatory Prepayment. . . . . . . . . . . . . . . . 21 SECTION 2.12 Repayment. . . . . . . . . . . . . . . . . . . . . 21\nSECTION 3 NOTES EVIDENCING THE LOANS . . . . . . . . . . . . . 22 SECTION 3.1 Notes . . . . . . . . . . . . . . . . . . . . . . . 22\nSECTION 4 INTEREST, FEES AND COSTS . . . . . . . . . . 22 SECTION 4.1 Interest . . . . . . . . . . . . . . . . . . . . . 22 SECTION 4.2 Fees. . . . . . . . . . . . . . . . . . . . . . . . 23 (a) Closing Fee. . . . . . . . . . . . . . . . . . . . . . . 23 (b) Unused Commitment Fees. . . . . . . . . . . . . . . . . 23 (c) Letter of Credit Fees. . . . . . . . . . . . . . . . . . 23 (d) Letter of Credit Issuance Fees. . . . . . . . . . . . . 23 SECTION 4.3 Computation of Fees and Interest. . . . . . . . . . 24 SECTION 4.4 Increased Costs; Capital Adequacy . . . . . . . . . 24 SECTION 4.5 Funding Losses. . . . . . . . . . . . . . . . . . . 26\nSECTION 5 MAKING OF PAYMENTS . . . . . . . . . . . . . . . 26 SECTION 5.1 Payments by the Company . . . . . . . . . . . . . . 26 SECTION 5.2 Payments by the Banks to the Agent. . . . . . . . . 27 SECTION 5.3 Setoff . . . . . . . . . . . . . . . . . . . . . . 28 SECTION 5.4 Sharing of Payments. . . . . . . . . . . . . . . . 29\nSECTION 6 REPRESENTATIONS AND WARRANTIES . . . . . . . . . . . . 29 SECTION 6.1 Corporate Organization . . . . . . . . . . . . . . 29 SECTION 6.2 Authorization; No Conflict . . . . . . . . . . . . 30 SECTION 6.3 Validity and Binding Nature . . . . . . . . . . . . 30 SECTION 6.4 Financial Statements . . . . . . . . . . . . . . . 30\ni\nSECTION 6.5 Litigation and Contingent Liabilities . . . . . . . 30 SECTION 6.6 Employee Benefit Plans . . . . . . . . . . . . . . 31 SECTION 6.7 Investment Company Act . . . . . . . . . . . . . . 32 SECTION 6.8 Regulation U . . . . . . . . . . . . . . . . . . . 32 SECTION 6.9 Accuracy of Information . . . . . . . . . . . . . . 32 SECTION 6.10 Labor Controversies . . . . . . . . . . . . . . . . 32 SECTION 6.11 Tax Status . . . . . . . . . . . . . . . . . . . . 32 SECTION 6.12 No Default . . . . . . . . . . . . . . . . . . . . 33 SECTION 6.13 Compliance with Applicable Laws . . . . . . . . . . 33 SECTION 6.14 Insurance . . . . . . . . . . . . . . . . . . . . . 33 SECTION 6.15 Solvency. . . . . . . . . . . . . . . . . . . . . . 33 SECTION 6.16 Use of Proceeds. . . . . . . . . . . . . . . . . . 34 SECTION 6.17 Subsidiaries. . . . . . . . . . . . . . . . . . . . 34\nSECTION 7 COVENANTS . . . . . . . . . . . . . . . . . 34 SECTION 7.1 Reports, Certificates and Other Information . . . . 34 (a) Annual Report. . . . . . . . . . . . . . . . . . . . . . 35 (b) Interim Reports. . . . . . . . . . . . . . . . . . . . . 35 (c) Statutory Statements. . . . . . . . . . . . . . . . . . 35 (d) Reports to SEC. . . . . . . . . . . . . . . . . . . . . 35 (e) Certificates . . . . . . . . . . . . . . . . . . . . . . 35 (f) Notice of Default, Litigation and ERISA Matters . . . . 35 (g) Other Information . . . . . . . . . . . . . . . . . . . 36 SECTION 7.2 Corporate Existence and Franchises . . . . . . . . 36 SECTION 7.3 Books, Records and Inspections . . . . . . . . . . 36 SECTION 7.4 Insurance . . . . . . . . . . . . . . . . . . . . . 36 SECTION 7.5 Taxes and Liabilities . . . . . . . . . . . . . . . 37 SECTION 7.6 Cash Flow Coverage . . . . . . . . . . . . . . . . 37 SECTION 7.7 Net Worth. . . . . . . . . . . . . . . . . . . 37 SECTION 7.8 Funds for Refinancing. . . . . . . . . . . . . 37 SECTION 7.9 Indebtedness. . . . . . . . . . . . . . . . . 37 SECTION 7.10 Risk-Based Capital . . . . . . . . . . . . . . . . 38 SECTION 7.11 Real Estate Concentration. . . . . . . . . . . . . 38 SECTION 7.12 Investment Quality. . . . . . . . . . . . . . . . . 38 SECTION 7.13 Intentionally Omitted. . . . . . . . . . . . . . . 38 SECTION 7.14 Insurance Company Leverage Ratio. . . . . . . . . 38 SECTION 7.15 Intentionally Omitted. . . . . . . . . . . . . . . 38 SECTION 7.17 Change in Nature of Business . . . . . . . . . . . 39 SECTION 7.18 Depository Relationship . . . . . . . . . . . . . . 39 SECTION 7.19 Employee Benefit Plans . . . . . . . . . . . . . . 40 SECTION 7.20 Use of Proceeds . . . . . . . . . . . . . . . . . . 40 SECTION 7.21 Other Agreements . . . . . . . . . . . . . . . . . 40 SECTION 7.22 Compliance with Applicable Laws . . . . . . . . . . 40\nSECTION 7A UNRESTRICTED SUBSIDIARIES . . . . . . . . . . . . . 40 SECTION 7A.1 Unrestricted Subsidiaries. . . . . . . . . . . . . 40 SECTION 7A.2 Additional Unrestricted Subsidiaries. . . . . . . . 41 SECTION 7A.3 Effectiveness of Designation. . . . . . . . . . . . 42\nSECTION 8\nii\nCONDITIONS TO MAKING LOANS AND ISSUING LCS . . . . . . . . 42 SECTION 8.1 Initial Loans. . . . . . . . . . . . . . . . . . . 42 (a) Fees and Expenses . . . . . . . . . . . . . . . . . . . 42 (b) Documents . . . . . . . . . . . . . . . . . . . . . . . 42 SECTION 8.2 All Loans and LCs. . . . . . . . . . . . . . . . . 43 (a) No Default, etc. . . . . . . . . . . . . . . . . . . . . 44 (b) Notice. . . . . . . . . . . . . . . . . . . . . . . . . 44\nSECTION 9 EVENTS OF DEFAULT AND THEIR EFFECT . . . . . . . . . . . 44 SECTION 9.1 Events of Default . . . . . . . . . . . . . . . . . 44 (a) Nonpayment of the Loan . . . . . . . . . . . . . . 44 (b) Nonpayment of Other Indebtedness . . . . . . . . . . . . 44 (c) Bankruptcy or Insolvency . . . . . . . . . . . . . . . . 45 (d) Specified Noncompliance with this Agreement . . . . . . 45 (e) Other Noncompliance with this Agreement . . . . . . . . 45 (f) Representations and Warranties . . . . . . . . . . . . . 45 (g) Employee Benefit Plans . . . . . . . . . . . . . . . . . 46 (h) Judgments . . . . . . . . . . . . . . . . . . . . . . . 46 SECTION 9.2 Effect of Event of Default . . . . . . . . . . . . 46\nSECTION 9A THE AGENT . . . . . . . . . . . . . . . . . 47 SECTION 9A.1 Appointment and Authorization . . . . . . . . . . . 47 SECTION 9A.2 Delegation of Duties . . . . . . . . . . . . . . . 47 SECTION 9A.3 Liability of Agent . . . . . . . . . . . . . . . . 47 SECTION 9A.4 Reliance by Agent . . . . . . . . . . . . . . . . . 47 SECTION 9A.5 Notice of Default . . . . . . . . . . . . . . . . . 48 SECTION 9A.6 Credit Decision . . . . . . . . . . . . . . . . . . 48 SECTION 9A.7 Indemnification . . . . . . . . . . . . . . . . . . 49 SECTION 9A.8 Agent in Individual Capacity . . . . . . . . . . . 50 SECTION 9A.9 Successor Agent . . . . . . . . . . . . . . . . . . 50\nSECTION 10 GENERAL . . . . . . . . . . . . . . . . . 50 SECTION 10.1 Amendments and Waivers . . . . . . . . . . . . . . 50 SECTION 10.2 Notices . . . . . . . . . . . . . . . . . . . . . . 51 SECTION 10.3 Accounting Terms; Computations . . . . . . . . . . 52 SECTION 10.4 Costs, Expenses and Taxes . . . . . . . . . . . . . 52 SECTION 10.5 Indemnification . . . . . . . . . . . . . . . . . . 53 SECTION 10.6 Captions and References . . . . . . . . . . . . . . 53 SECTION 10.7 No Waiver; Cumulative Remedies. . . . . . . . . . . 53 SECTION 10.8 Governing Law; Jury Trial; Severability . . . . . . 54 SECTION 10.9 Counterparts . . . . . . . . . . . . . . . . . . . 55 SECTION 10.10 Successors and Assigns . . . . . . . . . . . . . . 55 SECTION 10.11 Prior Agreements . . . . . . . . . . . . . . . . . 55 SECTION 10.12 Assignments; Participations . . . . . . . . . . . . 55 SECTION 10.13 Confidentiality. . . . . . . . . . . . . . . . . . 56 SECTION 10.14 Notification of Addresses, Etc. . . . . . . . 57\niii\nEXHIBITS\nEXHIBIT A Form of Note EXHIBIT B Form of Notice of Borrowing EXHIBIT C Form of Notice of Conversion/Continuation\niv\nCREDIT AGREEMENT\nThis Credit Agreement dated as of December 22, 1993 (this \"Agreement\"), is among (i) PIONEER FINANCIAL SERVICES, INC., a Delaware corporation (herein, together with its successors and assigns, called the \"Company\"), (ii) AMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO, as administrative agent (in such capacity, the \"Agent\") and (iii) AMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO, a national banking association (herein, together with its successors and assigns, called the \"ANB\"), FIRSTAR BANK MILWAUKEE, N.A., a national banking association (herein, together with its successors and assigns, called \"Firstar\") and BANK ONE, ROCKFORD, NA, a national banking association (herein, together with its successors and assigns, called \"Bank One\") (ANB, Firstar and Bank One collectively referred to as the \"Banks\" and individually as a \"Bank\").\nW I T N E S S E T H:\nWHEREAS, the Company has requested the Banks severally to make available to the Company a revolving credit facility for the purposes as set forth herein; and\nWHEREAS, the Banks are willing to make available to the Company a revolving facility in the aggregate amount of $20,000,000, under which each Bank severally shall lend funds and ANB, in its capacity as Issuing Bank, shall issue letters of credit from time to time to or for the benefit of the Company subject to the terms and conditions set forth in this Agreement;\nNOW, THEREFORE, in consideration of the mutual agreements contained herein, the parties hereto agree as follows:\nSECTION 1 CERTAIN DEFINITIONS\nSECTION 1.1 Terms Defined in this Agreement. When used herein the following terms shall have the following respective meanings:\n\"Adjusted Capital and Surplus\" means, with respect to each Insurance Subsidiary as of any date, the sum of (i) Capital and Surplus for such Insurance Subsidiary and (ii) the asset valuation reserve of such Insurance Subsidiary as of such date determined in accordance with Statutory Accounting Principles.\n\"Affiliate\" means, with respect to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. A Person shall be deemed to control another Person if such first Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of such other Person, whether through ownership of voting securities, by contract or otherwise.\n\"Agent's Payment Office\" means the address for payments set forth on the signature page hereto in relation to the Agent or such other address as the Agent may from time to time specify in accordance with Section 10.2.\n\"Agent-Related Persons\" means the Agent and any successor Agent appointed under Section 9A.9, together with their respective Affiliates, and the officers, directors, employees, agents and attorneys-in-fact of such Persons and Affiliates.\n\"Aggregate Commitment\" means the combined Commitments of the Banks in the amount of twenty million dollars ($20,000,000), as such amount may be reduced from time to time pursuant to this Agreement.\n\"Aggregate Stated Amount\" shall mean, as of the date of determination, the aggregate Stated Amounts of all LCs.\n\"Agreement\" means this Credit Agreement as it may be amended, supplemented or otherwise modified from time to time in accordance with the terms hereof.\n\"ANB\" - see Preamble.\n\"Applicable Margin\" means (a) with respect to Base Rate Loans, -0-, (b) with respect to CD Rate Loans, two percent (2.00%) per annum, and (c) with respect to Eurodollar Rate Loans, two percent (2.00%) per annum.\n\"Authorized Control Level RBC\" shall have the same meaning as the term \"Authorized Control Level RBC\" as defined in the NAIC Risk-Based Capital (RBC) for Life and/or Health Insurers Model Act, as such term may be amended by the NAIC from time to time.\n\"Authorized Officer\" means the Chairman, the President, any Executive Vice President, the Treasurer or any Vice Presidents of the Company that are designated as authorized officers pursuant to a resolution of the Board of Directors of the Company (each Bank shall be entitled to rely on such resolution until revoked or amended in writing by the Company).\n\"Available Cash Flow\" means, for any accounting period, without duplication of items that may be included in more than one of the following computations, the sum of (i) the aggregate Distributable Profits from the Insurance Subsidiaries for such period, and (ii) the combined net after tax income of the Non-Insurance Operating Subsidiaries for such period, plus depreciation, amortization and other non-cash expenses of the Non-Insurance Operating Subsidiaries for such period, minus all capitalized expenditures of the Non-Insurance Operating Subsidiaries for such period, all to be determined in accordance with GAAP.\n\"Bank\" or \"Banks\" - see Preamble.\n\"Bank Parties\" - see Section 10.5.\n\"Base Rate\" means at any time and from time to time the rate of\ninterest per annum which ANB most recently announced as its base rate at Chicago, Illinois, which rate shall not necessarily be the lowest rate of interest which ANB charges its customers.\n\"Base Rate Loan\" means a Loan that bears interest based on the Base Rate.\n\"Borrowing\" means a borrowing hereunder consisting of the several Loans made to the Company on the same day by each Bank pursuant to Section 2 hereof and having the same interest rate basis and Interest Period.\n\"Business Day\" means any day of the year on which each Bank is open for business in the city where such Bank's main office is located.\n\"Capital and Surplus\" means, with respect to each Insurance Subsidiary, such Insurance Subsidiary's capital and surplus as reported on such Insurance Subsidiary's Statutory Statements most recently filed with the department of insurance of such Insurance Subsidiary's state of incorporation.\n\"CD Rate\" means with respect to each Interest Period to be applicable to a CD Rate Loan, the rate of interest per annum payable on a certificate or certificates of deposit purchased by the Company from ANB concurrently in connection with the extension of a CD Rate Loan.\n\"CD Rate Loan\" means a Loan that bears interest based on the CD Rate.\n\"Clean-up Date\" shall mean the first day of any Clean-up Period.\n\"Clean-up Period\" shall mean, during such period of twelve consecutive months determined on a rolling basis, any period of sixty consecutive days in which no Loans are outstanding.\n\"Closing Date\" means the date on which all conditions precedent set forth in Section 8.1 are satisfied or waived by all the Banks.\n\"Commitment\", with respect to each Bank, has the meaning specified in Section 2.1.\n\"Commitment Percentage\" means, as to any Bank, the percentage equivalent at the time of determination of such Bank's Commitment divided by the Aggregate Commitment.\n\"Company\" - see Preamble.\n\"Conversion Date\" means any date on which the Company converts a Base Rate Loan to a Eurodollar Rate Loan or a CD Rate Loan; a CD Rate Loan to a Eurodollar Rate Loan or a Base Rate Loan; or a Eurodollar Rate Loan to a CD Rate Loan or a Base Rate Loan.\n\"Debt Service Requirements\" means, for any accounting period, the aggregate of the principal, interest and other dividends, payments or\ndistributions made or required to be made (i) to each Bank under this Agreement, (ii) with respect to other Indebtedness and (iii) with respect to the Preferred Stock.\n\"Distributable Profits\" means, for any accounting period, (i) the greater of (A) 10% of the aggregate Capital and Surplus of all Insurance Subsidiaries, and (B) the aggregated net after-tax profits of all Insurance Subsidiaries, determined in accordance with Statutory Accounting Principles for such period minus (ii) the after-tax profits of each Principal Insurance Subsidiary that must be retained by such Principal Insurance Subsidiary to maintain the Total Adjusted Capital required by Section 7.10.y\n\"Dollar(s)\" and the sign \"$\" means lawful money of the United States of America.\n\"Environmental Laws\" means any and all federal, state or local environmental or health and safety-related laws, regulations, rules, ordinances, orders or directives.\n\"ERISA\" means the Employee Retirement Income Security Act of 1974, as amended, and any successor statute of similar import, together with the regulations thereunder and under the Internal Revenue Code of 1986, as amended, in each case as in effect from time to time. References to sections of ERISA shall be construed to also refer to any successor sections.\n\"ERISA Affiliate\" means any corporation, trade or business that is, along with the Company, a member of a controlled group of corporations or a controlled group of trades or businesses, as described in Sections 414(b) and 414(c), respectively, of the Internal Revenue Code of 1986, as amended, or Section 4001 of ERISA.\n\"Eurodollar Rate Loan\" means a Loan that bears interest based on LIBOR.\n\"Event of Default\" means any of the events described in Section 9.1.\n\"FDIC\" means the Federal Deposit Insurance Corporation, or any entity succeeding to any of its principal functions.\n\"Federal Funds Rate\" means, for any day, the rate set forth in the weekly statistical release designated as H.15(519), or any successor publication, published by the Federal Reserve Board (including any such successor, \"H.15(519)\") for such date opposite the caption \"Federal Funds (Effective)\". If on any relevant day such rate is not yet published in H.15(519), the rate for such day will be the rate set forth in the daily statistical release designated as the Composite 3:30 p.m. Quotations for U.S. Government Securities, or any successor publication, published by the Federal Reserve Bank of New York (including any such successor, the \"Composite 3:30 p.m. Quotation\") for such day under the caption \"Federal Funds Effective Rate\". If on any relevant day the appropriate rate is not\nyet published in either H.15(519) or the Composite 3:30 p.m. Quotations, the rate for such day will be the arithmetic mean as determined by the Agent of the rates for the last transaction in overnight Federal funds arranged prior to 9:00 a.m. (New York time) on that day by each of three leading brokers of Federal funds transactions in New York City selected by the Agent.\n\"Federal Reserve Board\" means the Board of Governors of the Federal Reserve System, or any entity succeeding to any of its principal functions.\nGAAP means the generally accepted accounting principles in the United States of America with such changes thereto as (i) shall be consistent with the then-effective principles promulgated or adopted by the Financial Accounting Standards Board and its predecessors and successors and (ii) shall be concurred in by the independent certified public accountants of recognized standing certifying any financial statements of the Company and its Subsidiaries.\n\"Indebtedness\" means, as of any date, all indebtedness, obligations or other liabilities of the Company and its Subsidiaries as of such date (i) for borrowed money, (ii) evidenced by bonds, debentures, notes or other similar instruments for borrowed money, or (iii) pursuant to any guarantee of any indebtedness, obligations or other liabilities of any other Person of the type described in clauses (i) or (ii); provided, however, that (a) the amounts set forth in clauses (i), (ii) and (iii) shall not be double counted and (b) Indebtedness shall not include indebtedness, obligations or other liabilities of the Company to any Subsidiary or indebtedness, obligations or other liabilities of any Subsidiary to the Company or another Subsidiary.\n\"Indemnified Liabilities\" - see Section 10.5.\n\"Insurance Company Leverage Ratio\" means, for each Principal Insurance Subsidiary on an individual basis as of any date and for all Principal Insurance Subsidiaries on a combined basis as of any date, the ratio of Adjusted Capital and Surplus to Total Assets.\n\"Insurance Laws\" means any and all federal or state laws, regulations, rules, ordinances, orders or directives that pertain to the regulation of insurance companies, as such.\n\"Insurance Subsidiaries\" means, as of any date, all Subsidiaries of the Company that are engaged in the insurance business and are subject to regulation by the insurance commission or department of any state or other jurisdiction. The Insurance Subsidiaries of the Company as of the date of this Agreement are set forth in Schedule 6.17 attached hereto.\n\"Interest Payment Date\" means, (a) with respect to any CD Rate Loan or Eurodollar Rate Loan, the last day of each Interest Period applicable to such Loan, provided, however, that if any Interest Period for a CD Rate Loan or Eurodollar Rate Loan exceeds 90 days or three months, respectively, the date which falls 90 days or three months (as the case may be) after the\nbeginning of such Interest Period and after each Interest Payment Date thereafter shall also be an Interest Payment Date, and (b) with respect to any Base Rate Loan, the last Business Day of each calendar quarter and each date upon which such Loan is prepaid or converted to a Eurodollar Rate Loan or a CD Rate Loan.\n\"Interest Period\" means, (a) with respect to any Eurodollar Rate Loan, the period commencing on the Business Day the Loan is disbursed or continued or on the Conversion Date on which the Loan is converted to the Eurodollar Rate Loan and ending on the date one, two, three or six months thereafter, as selected by the Company in its Notice of Borrowing or Notice of Conversion/Continuation; and (b) with respect to any CD Rate Loan, the period commencing on the Business Day the CD Rate Loan is disbursed or continued or on the Conversion Date on which a Loan is converted to the CD Rate Loan and ending 30, 60, 90 or 180 days thereafter, as selected by the Company in its Notice of Borrowing or Notice of Conversion/Continuation;\nprovided that:\n(i) if any Interest Period pertaining to a Eurodollar Rate Loan or CD Rate Loan would otherwise end on a day which is not a Business Day, that Interest Period shall be extended to the next succeeding Business Day unless, in the case of a Eurodollar Rate Loan, the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the immediately preceding Business Day;\n(ii) any Interest Period pertaining to a Eurodollar Rate Loan that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Business Day of the calendar month at the end of such Interest Period; and\n(iii) no Interest Period for any Loan shall extend beyond a Clean-up Date or the Termination Date.\n\"Investment Grade Obligations\" means, as of any date for each Insurance Subsidiary, investments having an NAIC investment rating of 1 or 2; or a Standard & Poor's rating within the range of ratings from AAA to BBB-; or a Moody's rating within the range of ratings from Aaa to Baa3.\n\"Issuing Bank\" means American National Bank and Trust Company of Chicago in its capacity as issuing bank with respect to LCs issued under and pursuant to the terms of this Agreement.\n\"LC\" - see Section 2.2.\n\"LC Application\" - see Section 2.5.\n\"Liabilities\" means any and all of the Company's obligations to the\nBanks, howsoever created, arising or evidenced, whether direct or indirect, absolute or contingent, now or hereafter existing, or due or to become due, which arise out of or in connection with this Agreement or the Related Documents.\n\"LIBOR\" means, with respect to each Interest Period to be applicable to a Eurodollar Rate Loan, the rate of interest per annum determined by the Agent obtained by dividing (a) the Telerate Screen Rate for such Interest Period or (b) if the Telerate Screen Rate is unavailable at the time the LIBOR rate is to be determined, a rate determined on the basis of the offered rates for deposits in U.S. dollars for a period approximately equal to such Interest Period which appear on the Reuters Screen LIBO Page, as of 11:00 a.m., London time, on the day that is two London banking days preceding the beginning of such Interest Period by (c) a percentage equal to 100% minus the stated maximum rate (expressed as a percentage) as prescribed by the Federal Reserve Board of all reserve requirements (including, without limitation, any marginal, emergency, supplemental, special or other reserves) applicable on the first day of such Interest Period to any member bank of the Federal Reserve System in respect of Eurodollar funding or liabilities.\n\"Lien\" means any mortgage, pledge, lien, security interest or other charge or encumbrance, including the retained security title of a conditional vendor or lessor.\n\"Loan\" means an extension of credit by a Bank to the Company pursuant to Section 2, and may be a Base Rate Loan, CD Rate Loan or a Eurodollar Rate Loan.\n\"Majority Banks\" means at any time Banks then having Commitments equal to at least 51% of the Aggregate Commitment.\n\"Margin Stock\" has the meaning given to such term in Regulation U.\n\"Material Subsidiary\" means any Subsidiary of the Company, the financial condition of which, when consolidated with the financial condition of the Company, has a material effect on such financial condition of the Company, and shall include, without limitation, each Principal Insurance Subsidiary.\n\"Mortgage\" means, as of any date, as to each Insurance Subsidiary, the amount of such Insurance Subsidiary's mortgage loans on real estate calculated in accordance with Statutory Accounting Principles.\n\"Multiemployer Plan\" means a \"multiemployer plan\" as defined in ERISA.\n\"NAIC\" means the National Association of Insurance Commissioners and any successor thereto.\n\"Net Worth\" means, with respect to the Company, as at the time any determination thereof is made, the consolidated shareholders' equity (including common stock, additional paid-in capital, retained earnings, and\nnet unrealized gains and losses).\n\"Non-Insurance Operating Subsidiaries\" means, as of any date, all Subsidiaries of the Company that are not Insurance Subsidiaries. The Non- Insurance Operating Subsidiaries of the Company as of the date of this Agreement are set forth in Schedule 6.17 attached hereto.\n\"Non-Investment Grade Obligations\" means, as of any date, for each Insurance Subsidiary, any fixed maturity debt instrument investment that is not an Investment Grade Obligation. \"Note\" or \"Notes\" - see Section 3 and Exhibit A.\n\"Notice of Borrowing\" means a notice given by the Company to the Agent pursuant to Section 2.3, in substantially the form of Exhibit B.\n\"Notice of Conversion/Continuation\" means a notice given by the Company to the Agent pursuant to Section 2.4, in substantially the form of Exhibit C.\n\"PBGC\" means the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA.\n\"Permitted Liens\" - see Section 7.16.\n\"Person\" means an individual or a corporation, partnership, trust, incorporated or unincorporated association, joint venture, joint stock company, government (or any agency or political subdivision thereof) or other entity of any kind.\n\"Plan\" means an \"employee pension benefit plan\", as such term is defined in Section 3(2) of ERISA, an \"employee welfare benefit plan,\" as such term is defined in Section 3(1) of ERISA, or any bonus, deferred compensation, stock purchase, stock option, severance, salary continuation, vacation, sick leave, fringe benefit, incentive, insurance, welfare or similar arrangement.\n\"Policy Liabilities\" means the aggregate liabilities of a Principal Insurance Subsidiary for future policy benefits with respect to life and annuity policies issued by such Principal Insurance Subsidiary, determined in accordance with GAAP.\n\"Preferred Stock\" means the shares of the Company's Cumulative Convertible Exchangeable Preferred Stock, having a stated value of $25 per share.\n\"Principal Insurance Subsidiaries\" means, as of any date, any Insurance Subsidiary that is or becomes engaged in a material amount of insurance business and has been designated in writing by all of the Banks and the Company as a Principal Insurance Subsidiary. The following Insurance Subsidiaries shall be deemed to be Principal Insurance Subsidiaries as of the date of this Agreement and until designated otherwise by all of the Banks and the Company : Pioneer Life Insurance\nCompany of Illinois, an Illinois corporation; National Group Life Insurance Company, an Illinois corporation; and Manhattan National Life Insurance Company, an Illinois corporation.\n\"Real Estate Concentration Ratio\" means, as of any date, as to each Insurance Subsidiary, the ratio of (a) the sum of (i) Real Estate Investments plus (ii) Mortgages to (b) Capital and Surplus.\n\"Real Estate Investments\" means, as of any date, as to each Insurance Subsidiary, the sum of (a) the book value of properties acquired in satisfaction of debt calculated in accordance with Statutory Accounting Principles plus (b) the investment in investment real estate calculated in accordance with Statutory Accounting Principles; provided, that the properties occupied by the Company or any Subsidiary shall be excluded from the calculation of Real Estate Investments for purposes of this Agreement.\n\"Regulation U\" means Regulation U of the Board of Governors of the Federal Reserve System and any successor rule or regulation of similar import as in effect from time to time.\n\"Reimbursement Obligations\" - see Section 2.6.\n\"Related Documents\" means, collectively, this Agreement, each Note issued by the Company to each Bank, and all other documents, instruments and agreements executed by the Company and delivered to the Agent or the Banks pursuant to or in connection with this Agreement or any of the foregoing.\n\"Reportable Event\" means a reportable event (as defined in Section 4043(b) of ERISA) for which notice has not been waived pursuant to applicable regulations.\n\"Reuters Screen LIBO Page\" means the display page designated \"LIBO\" on the Reuters Monitor Money Rates Service (or such other page that may replace that page on such service for the purpose of displaying comparable rates).\n\"Stated Amount\" shall mean, with respect to any LC and as of the date of determination, the maximum amount for which a draw or demand for payment may then be made thereunder, whether or not such maximum amount is defined in such LC as the \"Stated Amount\" thereof.\n\"Statutory Accounting Principles\" means the accounting principles used in the preparation of Statutory Statements in accordance with the rules and regulations prescribed by the insurance commission or department of each Insurance Subsidiary's respective state of domicile in effect as of the date of this Agreement. In the event that there is a material change in such accounting principles subsequent to the date hereof, the covenants contained herein and affected by such change shall be adjusted as necessary to preserve the force and effect of such covenants by the Company (provided that prior to any such adjustment the Company shall consult with the Agent with respect to any such adjustment) subject to the reasonable objection of\nthe Majority Banks.\n\"Statutory Statements\" means, with respect to an Insurance Subsidiary, the annual or quarterly accounting statement for such Insurance Subsidiary prepared in accordance with Statutory Accounting Principles, as filed with the insurance commissioner or department of each jurisdiction in which such Insurance Subsidiary is subject to regulation.\n\"Subsidiary\" means a corporation, association or business entity of which the Company and/or its other Subsidiaries own, directly or indirectly, such number of outstanding shares as have more than 50% of the ordinary voting power for the election of such entity's directors.\n\"Telerate Screen Rate\" means, for any Interest Period to be applicable to a Eurodollar Rate Loan, the rate for deposits in U.S. dollars for a period approximately equal to such Interest Period which appears on Page 3750 of the Dow Jones Telerate Service (or such other page that may replace that page on such service for the purpose of displaying comparable rates) as of 11:00 a.m., London time, on the day that is two London banking days preceding the beginning of such Interest Period.\n\"Termination Date\" - means the earlier to occur of:\n(a) April 30, 1996; and\n(b) the date on which the Aggregate Commitment shall terminate in accordance with the provisions of this Agreement.\n\"Total Adjusted Capital\" shall have the same meaning as the term \"Total Adjusted Capital\" as defined in the NAIC Risk-Based Capital (RBC) for Life and/or Health Insurers Model Act, as such term may be amended by the NAIC from time to time.\n\"Total Assets\" means, as of any date, as to each Insurance Subsidiary, the total net admitted assets calculated as of such date in accordance with Statutory Accounting Principles.\n\"Total Invested Assets\" means, as of any date, as to each Insurance Subsidiary, the amount of such Insurance Subsidiary's cash and invested assets calculated in accordance with Statutory Accounting Principles.\n\"Unrestricted Subsidiary\" - see Section 7A.1.\nSECTION 2 BANK'S COMMITMENT; BORROWING PROCEDURES; LCs\nSECTION 2.1 Bank's Commitment to Make Loans. (a) On the terms and subject to the conditions set forth in this Agreement, each Bank severally agrees to make revolving loans (each such loan called a \"Loan\" and collectively called the \"Loans\") to the Company from time to time on any\nBusiness Day during the period from the Closing Date to the Termination Date, in an aggregate amount not to exceed at any time outstanding the amount set forth opposite such Bank's name on the signature page hereof under the heading \"Commitment\" (such amount as the same may be reduced pursuant to Section 2.9 or as a result of one or more assignments pursuant to Section 10.12, such Bank's \"Commitment\") minus the sum of (a) such Bank's Commitment Percentage of the aggregate Stated Amount of all LCs issued and outstanding and (b) such Bank's Commitment Percentage of the aggregate amount of all Reimbursement Obligations; provided, however, that after giving effect to any Borrowing of Loans, the aggregate principal amount of all outstanding Loans plus the sum of (c) the Aggregate Stated Amount of all LCs issued and outstanding and (d) the aggregate amount of all Reimbursement Obligations, shall not exceed the Aggregate Commitment. The Company and each Bank agree and acknowledge that each Bank's portion of each Borrowing of Loans shall be based pro rata on such Bank's Commitment Percentage determined at the time of such Borrowing.\n(b) The Company agrees that, with respect to each Bank's Commitment Percentage of each Loan that is a CD Rate Loan, the Company shall purchase from such Bank a certificate or certificates of deposit in an amount equal to such Bank's Commitment Percentage of each such Loan having a term equal to the Interest Period applicable to such Loan.\nSECTION 2.2 Issuing Bank's Commitment to Issue LCs. On the terms and subject to the conditions set forth in this Agreement, the Issuing Bank agrees, as the Company may from time to time request, to issue for the account of the Company letters of credit (each such letter of credit called an \"LC\" and collectively called the \"LCs\") from time to time on any Business Day during the period from the Closing Date to the Termination Date, in a Stated Amount not to exceed the Aggregate Commitment minus the sum of (a) the aggregate principal amount of all Loans then outstanding and not repaid, (b) the aggregate Stated Amount of all LCs previously issued and then outstanding and (c) the aggregate amount of all Reimbursement Obligations.\nSECTION 2.3 Procedure for Borrowing.\n(a) Each Borrowing of Loans shall be made upon the Company's irrevocable written notice delivered to the Agent in accordance with Section 10.2 in the form of a Notice of Borrowing (which notice must be received by the Agent prior to 11:00 a.m. (Chicago time) (i) two Business Days prior to the requested Borrowing date, in the case of Eurodollar Rate Loans, (ii) one Business Day prior to the requested Borrowing Date, in the case of CD Rate Loans, and (iii) on the requested Borrowing date, in the case of Base Rate Loans) specifying:\n(A) the amount of the Borrowing, which shall be in an aggregate minimum principal amount of one hundred thousand dollars ($100,000);\n(B) the requested Borrowing date, which shall be a Business Day;\n(C) whether the Borrowing is to be comprised of Eurodollar Rate Loans, CD Rate Loans or Base Rate Loans;\n(D) in the case of Eurodollar Rate Loans and CD Rate Loans, the duration of the Interest Period applicable to such Loans included in such notice. If the Notice of Borrowing shall fail to specify the duration of the Interest Period for any Borrowing comprised of CD Rate Loans or Eurodollar Rate Loans, such Interest Period shall be 30 days or one month, respectively; and\n(E) the account of the Company to which the proceeds of such Borrowing shall be deposited.\n(b) Upon receipt of the Notice of Borrowing, the Agent will promptly notify each Bank thereof and of the amount of such Bank's Commitment Percentage of the Borrowing.\n(c) Each Bank will make the amount of its Commitment Percentage of the Borrowing available to the Agent for the account of the Company at the Agent's Payment Office by 2:00 p.m. (Chicago time) on the Borrowing date requested by the Company in funds immediately available to the Agent. Promptly after receipt of all such amounts by the Agent, the proceeds of all such Loans will be disbursed by the Agent to such account of the Company designated in writing by the Company in the Notice of Borrowing in like funds as received by the Agent.\n(d) Unless the Majority Banks shall otherwise agree, during the existence of an Event of Default, the Company may not elect to have a Loan be made as, or converted into or continued as, a Eurodollar Rate Loan or a CD Rate Loan.\nSECTION 2.4 Conversion and Continuation Elections.\n(a) The Company may upon irrevocable written notice to the Agent in accordance with Section 2.4(b):\n(i) elect to convert on any Business Day, any Base Rate Loans (or any part thereof in an amount not less than $100,000) into Eurodollar Rate Loans or CD Rate Loans; or\n(ii) elect to convert on the last day of any Interst Period with respect thereto any Eurodollar Rate Loans (or any part thereof in an amount not less than $100,000) into Base Rate Loans or CD Rate Loans; or\n(iii) elect to convert on the last day of any Interest Period with respect thereto any CD Rate Loans (or any part thereof in an amount not less than $100,000) into Base Rate Loans or Eurodollar Rate Loans; or\n(iv) elect on the last day of any Interest Period\nwith respect to any Eurodollar Rate Loans or CD Rate Loans (or any part thereof in an amount not less than $100,000) to continue such Eurodollar Rate Loans or CD Rate Loans (or such part thereof) as such;\nprovided, that if the aggregate amount of CD Rate Loans or Eurodollar Rate Loans shall have been reduced, by payment, prepayment, or conversion of part thereof, to be less than $100,000, such CD Rate Loans or Eurodollar Rate Loans shall automatically convert into Base Rate Loans, and on and after such date until the amount of Loans shall exceed $100,000 the right of the Company to continue such Loans as, and convert such Loans into, Eurodollar Rate Loans or CD Rate Loans, as the case may be, shall terminate.\n(b) The Company shall deliver a Notice of Conversion/ Continuation in accordance with Section 10.2 to be received by the Agent not later than 11:00 a.m. (Chicago time) at least (i) two Business Days in advance of the Conversion Date or continuation date, if the Loans are to be converted into or continued as Eurodollar Rate Loans, (ii) one Business Day in advance of the Conversion Date or continuation date, if the Loans are to be converted into or continued as CD Rate Loans, and (ii) on the Conversion Date, if the Loans are to be converted into Base Rate Loans, specifying:\n(A) the proposed Conversion Date or continuation date;\n(B) the aggregate amount of Loans to be converted or continued;\n(C) the nature of the proposed conversion or continuation; and\n(D) the duration of the requested Interest Period.\n(c) If upon the expiration of any Interest Period applicable to CD Rate Loans or Eurodollar Rate Loans, the Company has failed to select timely a new Interest Period to be applicable to such CD Rate Loans or Eurodollar Rate Loans, as the case may be, or if any Event of Default shall then exist, the Company shall be deemed to have elected to convert such CD Rate Loans or Eurodollar Rate Loans into Base Rate Loans effective as of the expiration date of such current Interest Period.\n(d) Upon receipt of a Notice of Conversion/Continuation, the Agent will promptly notify each Bank thereof, or, if no timely notice is provided by the Company, the Agent will promptly notify each Bank of the details of any automatic conversion.\n(e) Unless the Majority Banks shall otherwise agree, during the existence of an Event of Default, the Company may not elect to have a Loan converted into or continued as a Eurodollar Rate Loan or a CD Rate Loan.\nSECTION 2.5 LC Documentation. (a) Each of the Company's requests\nfor an LC must be received by the Agent and the Issuing Bank at least two Business Days prior to the requested issue date of such LC, and shall be accompanied by a duly completed application therefor (the \"LC Application\") and such other documents, in support thereof as the Issuing Bank may reasonably require, and all of such applications and documents shall be in form and substance reasonably satisfactory to the Issuing Bank. In addition, the proposed form of each LC shall be in form and substance reasonably satisfactory to the Issuing Bank, due regard being given to the customs and conventions followed by the Issuing Bank in the issuance of letters of credit generally and the advice of the Banks from time to time given to the Issuing Bank as to necessary or desirable terms and provisions in the form of any such proposed LC. Upon receipt of any request for an LC, the Agent will promptly notify each Bank thereof and deliver to each Bank a copy of the LC Application and each other document received by the Agent in connection with such request for an LC. Each LC shall have an expiry date that shall in no event be later than one year after the Termination Date.\n(b) Subject to the terms and conditions of this Agreement, including, without limitation, Section 2.2, Section 2.5(a) and Section 8.2 hereof, the Issuing Bank shall issue the requested LC in accordance with the Issuing Bank's usual and customary business practices on the date requested for such issuance by the Company in the request made by the Company pursuant to the terms of Section 2.5(a) hereof. Notwithstanding the foregoing, if the Issuing Bank shall have received written notice from the Agent or any Bank on or before the Business Day prior to the date of the Issuing Bank's issuance of such proposed LC that one or more of the conditions set forth in Section 8.2 is not then satisfied, then, until such condition is satisfied and the Issuing Bank receives written notice thereof, the Issuing Bank shall have no obligation to issue any LC. Each Bank agrees that it shall not unreasonably give any such notice or unreasonably fail to withdraw any such notice.\n(c) The Issuing Bank shall promptly give the Agent notice upon the issuance of an LC hereunder and a copy of the LC so issued by such Issuing Bank, and the Agent shall promptly thereafter give notice of such issuance and a copy of such LC to the Banks. An LC otherwise issued in accordance with the terms of this Agreement shall be an LC notwithstanding any failure by the Issuing Bank or the Agent to provide any such notice or copies in a timely manner.\n(d) The Company may request that an LC be extended beyond its stated expiry date or otherwise renewed by giving the Issuing Bank and the Agent written notice of any such extension or renewal not later than ten Business Days prior to the date (the \"LC Extension Date\") that such LC would have expired absent such extension or renewal. Each such notice (an \"LC Extension Request\") shall specify the LC that is being extended or renewed and the proposed new expiration date of such LC. The Agent shall promptly advise each Bank of its receipt of, and provide to each Bank a copy of, each LC Extension Request. The new expiration date proposed for any LC may not be a date that is on or after one year after the Termination Date. Following proper delivery of an LC Extension Request pursuant to\nthis Section, the Issuing Bank shall, subject to Section 8.2, extend the expiration date of or renew any LC issued by the Issuing Bank. Notwithstanding the foregoing, if the Issuing Bank shall have received written notice from the Agent or any Bank on or before the Business Day prior to the Issuing Bank's proposed extension of the expiration date of an LC that one or more of the conditions set forth in Section 8.2 is not then satisfied, then, until such condition is satisfied and the Issuing Bank receives written notice thereof, the Issuing Bank shall have no obligation to extend the expiration date of such LC.\n(e) The Company may request that an LC be amended at any time by giving the Issuing Bank and the Agent written notice thereof not later than ten Business Days prior to the date proposed for such amendment. Each such notice (an \"LC Amendment Request\") shall specify in reasonable detail the changes that are then being requested to be made in the applicable LC and the changes, if any, in the information specified in the original request with respect to such LC delivered pursuant to Section 2.5(a). The Agent shall promptly advise the Banks of its receipt of, and provide a copy to each Bank of, each LC Amendment Request. If the Issuing Bank and the Agent, after consultation with any Bank that provides comments on any such LC Amendment Request, agree to such amendment, such amendment shall be given effect; provided, that (i) any extension of the expiration date or renewal of an LC shall be subject to the terms of Section 2.5(d), and (ii) any amendment which increases the face amount of an LC shall be deemed an issuance of a new LC with a face amount equal to the amount of such increase, and shall be subject to the provisions of this Agreement, including without limitation, Section 2.2, Section 2.5(a) and Section 8.2.\nSECTION 2.6 Agreement to Repay LC Drawings. (a) The Company hereby agrees to reimburse the Issuing Bank (collectively called the \"Reimbursement Obligations\" and individually a \"Reimbursement Obligation\"), for each payment or disbursement made by the Issuing Bank under any LC honoring any demand for payment made by the beneficiary thereunder immediately following the occurrence of any such payment or disbursement. Any Reimbursement Obligation not repaid on the date of the applicable payment or disbursement giving rise thereto shall bear interest on the amount so paid or disbursed by the Issuing Bank from the date of payment or disbursement made by the Issuing Bank to but not including the date the Issuing Bank is reimbursed therefor, at a rate per annum equal to the Base Rate from time to time in effect plus two percent (2.00%) per annum. Interest shall be computed for the actual number of days elapsed on the basis of a year consisting of 360 days.\n(b) Any action taken or omitted to be taken by the Issuing Bank under or in connection with any LC, if taken or omitted in the absence of willful misconduct or gross negligence, shall not put the Issuing Bank under any resulting liability to any Bank or, assuming that the Issuing Bank has complied with the applicable procedures specified herein and a Bank has not given a notice contemplated by Section 2.5(b) that continues in full force and effect, relieve any Bank of its obligations hereunder to the Issuing Bank.\nSECTION 2.6A Participations. (a) Upon the issuance by the Issuing Bank of any LC in accordance with the procedures and the terms set forth herein, each Bank shall be deemed to have irrevocably and unconditionally purchased and received from the Issuing Bank, without recourse or warranty, an undivided interest and participation to the extent of such Bank's Commitment Percentage in such LC (including, without limitation, all obligations of the Company with respect thereto other than amounts owing to the Issuing Bank under Section 4.2(d)), provided, that the participation of any Bank in any LC hereunder shall at no time exceed an amount equal to such Bank's Commitment minus the sum of (i) the aggregate principal amount of all Loans made by such Bank then outstanding and not repaid, (ii) such Bank's Commitment Percentage of the aggregate Stated Amount of all LCs previously issued and then outstanding and (iii) such Bank's Commitment Percentage of the aggregate amount of all Reimbursement Obligations.\n(b) (i) In the event that the Issuing Bank makes any payment or disbursement under any LC and the Company shall not have repaid such amount to the Issuing Bank pursuant to Section 2.6(a), the Issuing Bank shall promptly notify the Agent, which shall promptly notify each Bank, of such failure, and each Bank severally agrees to promptly and unconditionally pay to the Agent for the account of the Issuing Bank the amount of such Bank's Commitment Percentage of such payment or disbursement in same day funds and the Agent shall promptly pay such amount, and any other amounts received by the Agent for the Issuing Bank's account pursuant to this Section 2.6A(b), to the Issuing Bank. If the Agent so notifies such Bank prior to 11:00 A.M. (Chicago time) on any Business Day, such Bank shall make available to the Agent for the account of the Issuing Bank its Commitment Percentage of the amount of such payment or disbursement on such Business Day in same day funds (or on the next succeeding Business Day if notice is given after such time). The failure of any Bank to make available to the Agent for the account of the Issuing Bank its Commitment Percentage of any such payment or disbursement shall not relieve any other Bank of its obligation hereunder to make available to the Agent for the account of the Issuing Bank its Commitment Percentage of any payment or disbursement on the date such payment is to be made.\n(ii) In the event that any Bank fails to fund its Commitment Percentage of any payment or disbursement required to be made by the Banks to the Agent for the benefit of the Issuing Bank in accordance with the provisions of clause (i) above, until the earlier of such Bank's cure of such failure and the termination of the Bank's Commitment, the proceeds of all amounts thereafter paid or repaid to the Agent by the Company (or any Person on behalf of the Company) and contemplated hereunder to be disbursed to such Bank for application against amounts owing such Bank hereunder shall be disbursed instead to the Issuing Bank by the Agent on behalf of such Bank to cure, in full or in part, such failure by such Bank, and, upon such disbursement payment to such Bank shall be deemed to have been made. Notwithstanding anything in this Agreement to the contrary:\n(A) if the Issuing Bank has theretofore applied any portion of any cash collateral pledged to it to secure Reimbursement Obligations relating to the applicable LC as\nreimbursement for such Reimbursement Obligations, any amounts disbursed to the Issuing Bank by the Agent in accordance with this Section 2.6A(b)(ii) (net of any interest due the Issuing Bank) shall be used by the Issuing Bank to restore such cash collateral; and\n(B) a Bank shall be deemed to have cured its failure to fund its Commitment Percentage of any such required payment in respect of an LC at such time as an amount equal to such Bank's Commitment Percentage (determined as of the time of the Agent's receipt of notice of the failure by the Company to reimburse the Issuing Bank with respect to a payment or disbursement under such LC) of such required payment plus any interest accrued thereon is fully funded to the Issuing Bank, whether made by such Bank itself, by operation of the terms of this Section 2.6A(b)(ii) or by the Company directly to the Issuing Bank.\nInterest shall accrue on the amount that should have been paid by the defaulting Bank, for each day from the date such amount shall have been due until the date such amount is repaid to the Agent for the benefit of the Issuing Bank, at the Federal Funds Rate as in effect for each such day. The provisions of this Section 2.6A(b) shall not relieve the Company from paying interest at the applicable interest rate under Section 2.6(a).\n(c) Whenever the Issuing Bank receives a payment on account of a Reimbursement Obligation, including any interest thereon, as to which the Agent has received for the account of the Issuing Bank any payments from the Banks pursuant to this Section 2.6A, it shall promptly pay to the Agent and the Agent shall promptly pay to each Bank that has funded its participating interest therein, in the kind of funds so received, an amount equal to such Bank's Commitment Percentage thereof (according to the amounts so funded). Each such payment shall be made by the Issuing Bank or the Agent, as the case may be, on the Business day on which such Person receives the funds paid to it pursuant to the preceding sentence, if received prior to 11:00 a.m. (Chicago time) on such Business Day, and otherwise on the next succeeding Business Day. If the Issuing Bank or the Agent, as the case may be, shall fail to pay to any Bank the amount due such Bank pursuant to this Section when due, the Issuing Bank or the Agent, as the case may be, shall be obligated to pay to such Bank interest on the amount that should have been paid hereunder for each day from the date such amount shall have become due until the date such amount is paid, at the Federal Funds Rate as in effect for each such day.\n(d) The obligations of (i) a Bank to make payments to the Agent for the account of the Issuing Bank with respect to a payment or disbursement made under an LC issued pursuant to this Agreement and (ii) the Company to reimburse the Issuing Bank for payments and disbursements made by the Issuing Bank under any LC shall, in each case, be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim or defense to payment which the Company may have or have had against the Issuing Bank or such beneficiary, including, without\nlimitation, any defense based on the failure of such demand for payment to conform to the material terms of such LC or any nonapplication or misapplication by such beneficiary of the proceeds of such demand for payment or the legality, validity, regularity or enforceability of such LC or any document or contract related to or required to be presented under the terms of such LC; provided, however, that neither the Company nor the Banks shall be obligated to reimburse the Issuing Bank for any wrongful payment or disbursement made by such Issuing Bank under such LC as a result of acts or omissions constituting negligence or willful misconduct on the part of the Issuing Bank.\nSECTION 2.7 Mandatory Payment of LC Liability. The Company agrees that, upon (i) its receipt of a written notice from the Agent acting upon the written request of the Majority Banks stating that an Event of Default has occurred or (ii) its receipt of a written notice from the Agent that the Termination Date has occurred, it will promptly pay to the Agent for the account of the Issuing Bank an amount equal to the amount of the then aggregate Stated Amount of all LCs issued and outstanding hereunder. The Agent, the Issuing Bank and the Company hereby agree that the Company's payment of such amount shall be by means of purchasing from the Issuing Bank or its designee a certificate or certificates of deposit in an amount equal to the amount of the then aggregate Stated Amount of all LCs issued and outstanding hereunder. Any amounts so received by the Issuing Bank or certificates of deposit issued by the Issuing Bank or its designee pursuant to the provisions of the foregoing sentence shall be retained by the Issuing Bank as collateral security for the Reimbursement Obligation of the Company with respect to such LCs. Subject to Section 2.6A and so long as no Event of Default has occurred and is continuing, upon the expiration of any LC, the Issuing Bank will return to the Agent, and the Agent shall return to the Company, all such funds with respect to such LC not used to pay Reimbursement Obligations.\nSECTION 2.8 LC Operations. The Issuing Bank shall, promptly following its receipt thereof, (i) examine all documents purporting to represent a demand for payment by the beneficiary under any LC to ascertain that the same appear on their face to be in conformity with the terms and conditions of such LC and (ii) notify the Agent and the Company in writing of each such demand for payment. If, after examination, the Issuing Bank shall have determined that a demand for payment under such LC does not conform to the terms and conditions of such LC, then the Issuing Bank shall, as soon as reasonably practicable, give notice to the beneficiary, the Agent and the Company to the effect that negotiation was not in accordance with the terms and conditions of such LC, stating the reasons therefor and that the relevant document is being held at the disposal of such beneficiary or is being returned to such beneficiary, as the Issuing Bank may elect. The beneficiary may attempt to correct any such nonconforming demand for payment under such LC if, and to the extent that, such beneficiary is entitled (without regard to the provisions of this sentence) and able to do so. If the Issuing Bank determines that a demand for payment under such LC conforms to the terms and conditions of such LC, then the Issuing Bank shall make payment to the beneficiary in accordance with the terms of such LC. The Issuing Bank shall have the right to\nrequire the beneficiary to surrender such LC to the Issuing Bank on the stated expiration date of such LC.\nSECTION 2.9 Voluntary Termination or Reduction of Commitments. The Company may, upon not less than one Business Days' prior written notice to the Agent, terminate the Aggregate Commitment or permanently reduce the Aggregate Commitment by an aggregate minimum amount of $100,000; provided that no such reduction or termination shall be permitted if, after giving effect thereto and to any prepayments of the Loans made on the effective date thereof, the sum of (i) the then outstanding principal amount of the Loans, (ii) the Aggregate Stated Amount of all LCs issued and outstanding and (iii) the aggregate amount of all Reimbursement Obligations, would exceed the amount of the Aggregate Commitment then in effect. Any reduction of the Aggregate Commitment shall be applied to each Bank's Commitment in accordance with such Bank's Commitment Percentage. All commitment fees with respect to the portion of the Commitments that are being reduced that have accrued to, but not including, the effective date of any reduction or termination of Commitments, shall be paid on the effective date of such reduction or termination.\nSECTION 2.10 Optional Prepayments. Subject to Section 4.5, the Company may, at any time or from time to time, ratably prepay Loans in whole or in part in any amount; provided that the Company's written notice of such prepayment shall be delivered to the Agent in accordance with Section 10.2 prior to 11:00 a.m. (Chicago time) (i) two Business Days prior to the requested date of prepayment, in the case of Eurodollar Rate Loans; (ii) one Business Day prior to the requested date of prepayment, in the case of CD Rate Loans, and (iii) on the requested date of prepayment, in the case of Base Rate Loans. Such notice of prepayment shall specify the date of repayment, the aggregate amount of such prepayment, and whether such prepayment is of Base Rate Loans, CD Rate Loans or Eurodollar Rate Loans, or any combination thereof. Such notice shall not thereafter be revocable by the Company. The Agent will promptly notify each Bank of such notice and of such Bank's Commitment Percentage of such prepayment. If such notice is given by the Company, the Company shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein, together with accrued interest to each such date on the amount prepaid and any amounts required pursuant to Section 4.5.\nSECTION 2.11 Mandatory Prepayment. On each Clean-up Date, the Company shall make a mandatory prepayment to the Agent for the benefit of the Banks of the outstanding principal amount of all Loans outstanding on such Clean-up Date together with accrued interest to such Clean-up Date on such Loans and any amounts required pursuant to Section 4.5.\nSECTION 2.12 Repayment. The Company shall repay to the Agent for the benefit of the Banks in full on the Termination Date the aggregate principal amount of the Loans outstanding on the Termination Date.\nSECTION 3\nNOTES EVIDENCING THE LOANS\nSECTION 3.1 Notes. Each Bank's Loans shall be evidenced by a promissory note (herein, as the same may be amended, modified or supplemented from time to time, and together with any renewals thereof or exchanges or substitutions therefor, individually called a \"Note\" and collectively called the \"Notes\"), substantially in the form set forth in Exhibit A, with appropriate insertions, dated the Closing Date, payable to the order of such Bank in the principal amount equal to such Bank's Commitment or the aggregate principal amount of the Loans outstanding to such Bank, whichever is less. The date and amount of the Loans made by each Bank and of each repayment of principal thereon received by such Bank shall be recorded by such Bank in its records or, at its option, on the schedule attached to its Note. The aggregate unpaid principal amount so recorded shall be rebuttable presumptive evidence of the principal amount owing and unpaid on such Note to such Bank. The failure so to record any such amount or any error in so recording any such amount, however, shall not limit or otherwise affect the Company's obligations hereunder or under such Note to repay the principal amount of the Loans evidenced by such Note together with all interest accruing thereon. Each Note shall provide for the payment of interest as provided in Section 4.\nSECTION 4 INTEREST, FEES AND COSTS\nSECTION 4.1 Interest.\n(a) Subject to Section 4.1(c), each Loan shall bear interest on the outstanding principal amount thereof from the date when made until it becomes due at a rate per annum equal to the CD Rate, LIBOR or the Base Rate, as the case may be, plus the Applicable Margin.\n(b) Interest on each Loan shall be paid in arrears on each Interest Payment Date. Interest shall also be paid on the date of any prepayment of Loans pursuant to Section 2.10 for the portion of the Loans so prepaid and upon payment (including prepayment) in full thereof, including, without limitation, on each Clean-up Date pursuant to Section 2.11 and, during the existence of any Event of Default, interest shall be paid on demand.\n(c) If any amount of principal of or interest on any Loan, or any other amount payable hereunder or under any of the other Loan Documents is not paid in full when due (whether at stated maturity, by acceleration, demand or otherwise), the Company agrees to pay interest on such unpaid principal or other amount, from the date such amount becomes due until the date such amount is paid in full, payable on demand, at a fluctuating rate per annum equal to the Base Rate plus two percent (2.00%) per annum.\nSECTION 4.2 Fees.\n(a) Closing Fee. On the Closing Date the Company shall pay to\nthe Agent for the account of each Bank a one-time closing fee equal to 0.30% of each Bank's Commitment.\n(b) Unused Commitment Fees. The Company shall pay to the Agent for the account of each Bank an unused commitment fee at the rate of 0.30% per annum on the daily average amount of the difference between such Bank's Commitment from time to time in effect minus the sum of (i) such Bank's Commitment Percentage of the aggregate principal amount of all Loans then outstanding and not repaid, (ii) such Bank's Commitment Percentage of the aggregate Stated Amount of all LCs issued and outstanding and (iii) such Bank's Commitment Percentage of the aggregate amount of all Reimbursement Obligations. The Agent shall provide the Company with an invoice for the amount of the unused commitment fee due to each Bank for each quarterly period ending on the last day of each March, June, September and December, commencing on December 31, 1993. Such unused commitment fee shall accrue from the Closing Date to the Termination Date and shall be due and payable quarterly in arrears no later than thirty (30) days after the Company receives the invoice referred to above, with the final payment to be made on the Termination Date; provided that, in connection with any reduction or termination of Commitments pursuant to Section 2.9, the accrued, unused commitment fee calculated for the period ending on such date shall also be paid on the date of such reduction or termination, with the next succeeding quarterly payment being calculated on the basis of the period from the reduction or termination date to such quarterly payment date. The unused commitment fees provided in this subsection shall accrue at all times after the Closing Date, including during any Clean-up Period.\n(c) Letter of Credit Fees. The Company shall pay to the Agent for the account of each Bank a letter of credit fee at the rate of 1.00% per annum of such Bank's Commitment Percentage of the aggregate Stated Amount of all LCs issued and outstanding. Such letter of credit fee shall accrue from the date of issuance of each LC to the date of termination of such LC as set forth in such LC and shall be due and payable quarterly in advance, with the first such payment due on the date of issuance of each such LC.\n(d) Letter of Credit Issuance Fees. The Company shall pay to the Agent for the account of the Issuing Bank a letter of credit issuance fee on the date of issuance of each LC at a rate to be determined according to the standard fee schedules of the Issuing Bank with respect to letters of credit.\nSECTION 4.3 Computation of Fees and Interest.\n(a) All computations of interest in respect of the Base Rate and all computations of letter of credit fees pursuant to Section 4.2(c) shall be made on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed. All other computations of fees and interest under this Agreement shall be made on the basis of a 360-day year and actual days elapsed. Interest and fees shall accrue during each period during which interest or such fees are computed from and including the first day thereof to but excluding the last day thereof.\n(b) The Agent will, with reasonable promptness, notify the Company and the Banks of each determination of a Eurodollar Rate or CD Rate; provided, however, that any failure to do so shall not relieve the Company of any liability hereunder or provide the basis for any claim against the Agent. Each determination of an interest rate by the Agent pursuant hereto shall be conclusive and binding on the Company and the Banks in the absence of manifest error.\nSECTION 4.4 Increased Costs; Capital Adequacy.\n(a) If (i) Regulation D of the Board of Governors of the Federal Reserve System, or (ii) after the date hereof, the adoption of any applicable law, rule or regulation, or any change therein, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by a Bank with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency issued after the date hereof,\n(i) shall subject such Bank to any tax, duty or other charge with respect to any Eurodollar Rate Loan or CD Rate Loan made by such Bank, the Note issued to such Bank, such Bank's obligation to make or maintain any such Loan, any LC issued by the Issuing Bank or the Issuing Bank's obligation to make or maintain any such LC, or shall change the basis of taxation of payments to a Bank or the Issuing Bank, as the case may be, of the principal of or interest on any such Eurodollar Rate Loan or CD Rate Loan or such LC or any other amounts due under this Agreement in respect of any such Eurodollar Rate Loan or CD Rate Loan or such LC or such Bank's or the Issuing Bank's, as the case may be, obligation to make or maintain any such Eurodollar Rate Loan or CD Rate Loan or such LC (except for changes in the rate of tax on the overall net income of such Bank imposed by the jurisdiction in which such Bank's principal executive office is located); or\n(ii) shall impose, modify or deem applicable any reserve (including, without limitation, any reserve imposed by the Federal Reserve Board but excluding, in the case of Eurodollar Rate Loans, any reserve prescribed by the Federal Reserve Board included in the determination of LIBOR), special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, such Bank;\nand the result of any of the foregoing is to increase the cost to such Bank of making or maintaining any Loan or to the Issuing Bank of issuing or maintaining any LC, or to reduce the amount of any sum received or receivable by such Bank or the Issuing Bank, as the case may be, under this Agreement or under its Note with respect thereto, then within 30 days after demand by such Bank, with a copy of such demand to the Agent (which demand shall be accompanied by a statement setting forth in reasonable detail the\nbasis of such demand), the Company shall pay to the Agent for the account of such Bank such additional amount or amounts as will compensate such Bank for such increased costs or such reduction, provided, however, that any such amount or amounts payable by the Company shall not exceed the increased costs or amount of reduction of such Bank or the Issuing Bank, as the case may be, in direct proportion to any such Loan or any such LC.\n(b) If either (i) the introduction of or any change in or in the interpretation of any law or regulation or (ii) compliance by a Bank with any new guideline or request from any central bank or other governmental authority affects or would affect the amount of capital required or expected to be maintained by such Bank or any corporation controlling such Bank and the amount of such capital is increased by or based upon the existence of such Bank's commitment to make or maintain any Loan by such Bank hereunder or in the case of the Issuing Bank, its commitment to issue any LC hereunder, then, within 30 days after demand by such Bank, with a copy to the Agent (which demand shall set forth in reasonable detail the basis of such demand), the Company shall pay to the Agent for the account of such Bank, from time to time as reasonably specified by such Bank, additional amounts sufficient to compensate such Bank in the light of such circumstances, to the extent that such Bank reasonably determines such increase in capital to be allocable to the existence of such Bank's commitment to make or maintain any Loan hereunder or in the case of the Issuing Bank, its commitment to issue any LC hereunder, provided, however, that any such amount or amounts payable by the Company shall not exceed the increased amount of capital required to be maintained by such Bank and allocable to any such Loan or any such LC, as the case may be, in direct proportion to any such Loan or any such LC.\nSECTION 4.5 Funding Losses. The Company agrees to reimburse each Bank and to hold each Bank harmless from any loss or expense which such Bank may sustain or incur as a consequence of:\n(a) the failure of the Company to make when due any payment of principal of any Eurodollar Rate Loan or CD Rate Loan (including payments made after any acceleration thereof) not resulting from any Bank's failure to act;\n(b) the failure of the Company to borrow, continue or convert a Loan after the Company has given (or is deemed to have given) a Notice of Borrowing or a Notice of Conversion/ Continuation;\n(c) the failure of the Company to make any prepayment after the Company has given a notice in accordance with Section 2.10 or Section 2.11;\n(d) the prepayment of a Eurodollar Rate Loan or a CD Rate Loan on a day which is not the last day of the Interest Period with respect thereto; or\n(e) the conversion pursuant to Section 2.4 of any Eurodollar Rate Loan or CD Rate Loan to a Loan of another type on a day that is not the last day of the Interest Period with respect thereto;\nincluding, in each case, (i) any such loss or expense arising from the liquidation or reemployment of funds obtained by it to maintain its Eurodollar Rate Loans or CD Rate Loans hereunder or from fees payable to terminate the deposits from which such funds were obtained and (ii) with respect to any certificate of deposit purchased by the Company from each Bank in connection with a CD Rate Loan, any penalty assessed by such Bank for the early withdrawal of the funds deposited under any such certificate of deposit in accordance with such Bank's usual and customary practices.\nSECTION 5 MAKING OF PAYMENTS\nSECTION 5.1 Payments by the Company.\n(a) All payments (including prepayments) to be made by the Company on account of principal, interest, fees and other amounts required hereunder shall, except as otherwise expressly provided herein, be made to the Agent for the ratable account of the Banks at the Agent's Payment Office without condition or reservation of right in immediately available funds, no later than 12:00 noon (Chicago time) on the date specified herein. Any payment which is received by the Agent later than 12:00 noon (Chicago time) shall be deemed to have been received on the immediately succeeding Business Day and any applicable interest or fee shall continue to accrue. The Agent will promptly distribute to each Bank its Commitment Percentage of such principal, interest, fees or other amounts, in like funds as received, but in any event shall distribute such amounts no later than the close of business on the date received by the Agent if received by the Agent no later than 12:00 noon on such date. If the Agent shall fail to pay to any Bank the amount due such Bank pursuant to this Section when due, the Agent shall be obligated to pay to such Bank interest on the amount that should have been paid hereunder for each day from the date such amount shall have become due until the date such amount is paid, at the Federal Funds Rate as in effect for each such day.\n(b) Whenever any payment hereunder shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of interest or fees, as the case may be; subject to the provisions set forth in the definition of \"Interest Period\" herein.\n(c) Unless the Agent shall have received written notice from the Company prior to the date on which any payment is due to the Banks hereunder that the Company will not make such payment in full as and when required hereunder, the Agent may assume that the Company has made such payment in full to the Agent on such date in immediately available funds and the Agent may (but shall not be so required), in reliance upon such assumption, cause to be distributed to each Bank on such due date an amount equal to the amount then due such Bank. If and to the extent the Company shall not have made such payment in full to the Agent, each Bank shall repay to the Agent on demand such amount distributed to such Bank, together\nwith interest thereon for each day from the date such amount is distributed to such Bank until the date such Bank repays such amount to the Agent, at the Federal Funds Rate as in effect for each such day.\nSECTION 5.2 Payments by the Banks to the Agent.\n(a) Unless the Agent shall have received written notice from a Bank, with respect to each Borrowing (other than a Borrowing of Base Rate Loans), at least one Business Day prior to the date of any proposed Borrowing (or, in the case of a Borrowing of Base Rate Loans, on the applicable Borrowing date), that such Bank will not make available to the Agent as and when required hereunder for the account of the Company the amount of that Bank's Commitment Percentage of the Borrowing, the Agent may assume that each Bank has made such amount available to the Agent in immediately available funds on the Borrowing date and the Agent may (but shall not be so required), in reliance upon such assumption, make available to the Company on such date a corresponding amount. If and to the extent any Bank shall not have made its full amount available to the Agent in immediately available funds and the Agent in such circumstances has made available to the Company such amount, that Bank shall on the next Business Day following the date of such Borrowing make such amount available to the Agent, together with interest at the Federal Funds Rate for and determined as of each day during such period. A notice of the Agent submitted to any Bank with respect to amounts owing under this Section 5.2(a) shall be conclusive, absent manifest error. If such amount is so made available, such payment to the Agent shall constitute such Bank's Loan on the date of Borrowing for all purposes of this Agreement. If such amount is not made available to the Agent on the next Business Day following the date of such Borrowing, the Agent shall notify the Company of such failure to fund and, upon demand by the Agent, the Company shall pay such amount to the Agent for the Agent's account, together with interest thereon for each day elapsed since the date of such Borrowing, at a rate per annum equal to the interest rate applicable at the time to the Loans comprising such Borrowing.\n(b) The failure of any Bank to make any Loan on any date of Borrowing shall not relieve any other Bank of any obligation hereunder to make a Loan on the date of such Borrowing, but no Bank shall be responsible for the failure of any other Bank to make the Loan to be made by such other Bank on the date of any Borrowing.\nSECTION 5.3 Setoff.\n(a) The Company agrees that, if at any time (i) any amount owing by it under this Agreement or any Related Document is then due and payable to a Bank or (ii) any Event of Default shall have occurred and be continuing, then such Bank, in its sole discretion, may apply to the payment of the Liabilities any and all balances, credits, deposits, accounts or moneys of the Company then or thereafter with such Bank.\n(b) Without limitation of Section 5.3(a), the Company agrees that, upon and during the continuance of any Event of Default, such Bank is\nhereby authorized, at any time and from time to time, without notice to the Company, (i) to set off against and to appropriate and apply to the payment of the Liabilities (whether matured or unmatured) any and all amounts which such Bank is obligated to pay over to the Company (whether matured or unmatured, and, in the case of deposits, whether general or special, time or demand and however evidenced) and (ii) pending any such action, to the extent necessary, to hold such amounts as collateral to secure such Liabilities.\n(c) Notwithstanding any other provision of this Agreement, the Notes or any other Related Document, the Banks shall not set off against, or appropriate or apply to the payment of any Liabilities, any of the deposits, accounts or other assets of any Insurance Subsidiary.\nSECTION 5.4 Sharing of Payments. If, other than as expressly provided elsewhere herein, any Bank shall obtain on account of the Liabilities held by such Bank any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) in excess of its Commitment Percentage of payments on account of the Liabilities obtained by all the Banks, such Bank shall promptly (a) notify the Agent of such fact and (b) upon demand purchase from the other Banks a portion of the Liabilities held by such other Banks as shall be necessary to cause such purchasing Bank to share the excess payment ratably with each of them based upon each Bank's Commitment Percentage; provided, however, that if all or any portion of such excess payment is thereafter recovered from the purchasing Bank, such purchase shall to that extent be rescinded and each other Bank shall repay to the purchasing Bank the purchase price paid therefor, together with an amount equal to such paying Bank's Commitment Percentage of any interest or other amount paid or payable by the purchasing Bank in respect of the total amount so recovered. The Company agrees that any Bank so purchasing a portion of another Bank's Liabilities pursuant to this Section 5.4 may, to the fullest extent permitted by law, exercise all of its rights of payment (including the right of setoff) with respect to such purchased Liabilities as fully as if such Bank were the direct creditor of the Company in the amount of such purchased Liabilities. The Agent will keep records (which shall be conclusive and binding in the absence of manifest error) of amounts purchased pursuant to this Section 5.4 and will in each case notify the Banks following any purchases or repayments.\nSECTION 6 REPRESENTATIONS AND WARRANTIES\nTo induce each Bank to enter into this Agreement and to make Loans and to induce the Issuing Bank to enter into this Agreement and issue LCs hereunder, the Company represents and warrants to each Bank, the Issuing Bank and the Agent that:\nSECTION 6.1 Corporate Organization. The Company is a corporation duly existing and in good standing under the laws of the State of Delaware and is duly qualified and in good standing as a foreign corporation\nauthorized to do business in Illinois, which is the only other jurisdiction in which the Company is required to be duly qualified and in good standing as a foreign corporation. The Company's failure to be so qualified in any other jurisdiction does not materially and adversely affect the Company's business, operations or financial condition or its ability to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 6.2 Authorization; No Conflict. The Company's execution, delivery and performance of this Agreement and each of the Related Documents to which it is a party and the consummation of the transactions contemplated by this Agreement and each of the Related Documents are within the Company's corporate powers, have been duly authorized by all necessary corporate action, require no governmental, regulatory or other approval, and (a) do not and will not contravene or conflict with any provision of (i) any law the failure of the Company to comply with in the Company's determination materially and adversely affects the Company's business, operations or financial condition or its ability to perform its obligations hereunder and under the Related Documents to which it is a party, (ii) any judgment, decree or order applicable to the Company, or (iii) the Company's articles of incorporation or by-laws, and (b) do not and will not contravene or conflict with any provision of any agreement or instrument binding upon the Company or upon any property of the Company that in the Company's determination materially and adversely affects the Company's business, operations or financial condition or its ability to perform its obligations hereunder or under the Related Documents to which it is a party.\nSECTION 6.3 Validity and Binding Nature. This Agreement and the Related Documents to which the Company is a party are (or, when duly executed and delivered, will be) the legal, valid and binding obligations of the Company enforceable against the Company in accordance with their respective terms.\nSECTION 6.4 Financial Statements. The annual and quarterly historical balance sheets and statements of operations that have been or shall hereafter be furnished to the Agent, the Issuing Bank or any Bank by or at the direction of the Company for the purposes of or in connection with this Agreement do and will present fairly the financial condition of the Persons involved as of the dates thereof and the results of their operations for the period(s) covered thereby, all in accordance with GAAP, consistently applied, unless otherwise noted therein.\nSECTION 6.5 Litigation and Contingent Liabilities.\n(a) No litigation (including, without limitation, derivative actions), arbitration proceedings, governmental proceedings or investigations or regulatory proceedings are pending or, to the best of its knowledge, threatened against the Company or any Material Subsidiary which in the Company's determination materially and adversely affects the Company's or such Material Subsidiary's business, operations or financial condition or the Company's ability to perform its obligations hereunder and\nunder the Related Documents to which it is a party. In addition, to the best of the Company's knowledge, there are no inquiries, formal or informal, which give rise to such actions, proceedings or investigations.\n(b) The Company and, to the best of the Company's knowledge, each Material Subsidiary has obtained all licenses, permits, franchises and other governmental authorizations necessary to the ownership of its properties or to the conduct of its businesses, including without limitation all licenses, permits, franchises and other governmental authorizations required under all applicable Environmental Laws, a failure to obtain or violation of which in the Company's determination materially and adversely affects the Company's or such Material Subsidiary's business, operations or financial condition or the Company's ability to perform its obligations hereunder and under the Related Documents to which it is a party.\n(c) The Company does not have any material contingent liabilities required to be disclosed pursuant to GAAP that are not provided for or disclosed in the financial statements referred to in Section 6.4 hereof.\nSECTION 6.6 Employee Benefit Plans. To the best of the Company's knowledge, each Plan complies in all material respects with all applicable statutes and governmental rules and regulations (including, without limitation, the requirements of Section 401(a) of the Internal Revenue Code of 1986, as amended, to the extent that such Plan is intended to conform to that section) and during the 12-consecutive-month period prior to the Closing Date, (i) no Reportable Event has occurred and is continuing with respect to any Plan subject to Title IV of ERISA, (ii) neither the Company nor any ERISA Affiliate has withdrawn from any Plan subject to Title IV of ERISA or instituted steps to do so, (iii) no steps have been instituted to terminate any Plan subject to Title IV of ERISA, (iv) no contribution failure has occurred with respect to any Plan sufficient to give rise to a lien under Section 302(f) of ERISA, or (v) each Plan which is intended to be qualified pursuant to Section 401(a) of the Internal Revenue Code of 1986, as amended, has received a favorable determination letter. To the best of the Company's knowledge, no condition exists or event or transaction has occurred in connection with any Plan which would result in the incurrence by the Company or any ERISA Affiliate of any liability, fine or penalty, which in the Company's determination materially and adversely affects the Company's business, operations or financial condition, or the ability of the Company to perform its obligations hereunder and under the Related Documents to which it is a party. Neither the Company nor any ERISA Affiliate presently maintains, contributes to or, to the best of the Company's knowledge, has any liability (including current or potential withdrawal liability) with respect to any Multiemployer Plan. To the best of the Company's knowledge, neither the Company nor any ERISA Affiliate has any liability with respect to any funded or unfunded postretirement benefit for employees or former employees (including medical, health or life insurance) other than liability for continuation coverage described in Part 6 of Title I of ERISA.\nSECTION 6.7 Investment Company Act. The Company is not an \"investment company\" or a company \"controlled\" by an \"investment company\", within the meaning of the Investment Company Act of 1940, as amended.\nSECTION 6.8 Regulation U. The Company is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying Margin Stock.\nSECTION 6.9 Accuracy of Information. To the best of the Company's knowledge, all factual information heretofore or contemporaneously furnished by the Company to the Agent, the Issuing Bank or any Bank for purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all other factual information hereafter furnished by the Company to the Agent, the Issuing Bank or any Bank will be, true and accurate in every material respect on the date as of which such information is dated or certified, and the Company has not knowingly omitted and will not knowingly omit any material fact it deems necessary to prevent such information from being false or misleading.\nSECTION 6.10 Labor Controversies. There are no labor controversies pending or threatened against the Company or any Material Subsidiary which in the Company's determination materially and adversely affect the Company's or such Material Subsidiary's business, operations or financial condition or the Company's ability to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 6.11 Tax Status. Except as set forth in Schedule 6.11 hereto, the Company and, to the best of the Company's knowledge, each Material Subsidiary, have made or filed all income and other tax returns, reports and declarations required by any jurisdiction to which it is subject, have paid all taxes, assessments and other charges shown or determined to be due on such returns, reports and declarations (other than those being diligently contested in good faith by appropriate proceedings), and have set aside adequate reserves against liability for taxes, assessments and charges applicable to periods subsequent to those covered by such returns, reports and declarations, a failure of which to file, to pay or to set aside in the Company's determination materially and adversely affects the Company's or such Material Subsidiary's business, operations or financial condition or the Company's ability to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 6.12 No Default. No event has occurred and no condition exists which, upon the execution and delivery of, or consummation of any transaction contemplated by, this Agreement or any Related Document, or upon the funding of any Loan or the issuance of any LC, will constitute an Event of Default. The Company and each Material Subsidiary have not received notice of default with respect to any other material agreement, security or contract, except those for which a default exists that is not capable of being cured with the payment of money or as to which a good faith dispute exists.\nSECTION 6.13 Compliance with Applicable Laws. The Company and, to\nthe best of the Company's knowledge, each Material Subsidiary are in compliance with the requirements of all applicable laws, rules, regulations, and orders of all governmental authorities (Federal, state, local or foreign, and including, without limitation, Environmental Laws and Insurance Laws), a breach of which would in the Company's determination materially and adversely affect the Company's or such Material Subsidiary's business, operations or financial condition, or the ability of the Company to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 6.14 Insurance. The Company is in its sole determination, maintains adequate general liability, property and casualty insurance for its benefit under policies issued by insurers of recognized responsibility.\nSECTION 6.15 Solvency. After giving effect to the transactions contemplated hereby and by the Related Documents, the Company is not \"insolvent\", nor will the Company's incurrence of obligations to repay any Loan or to reimburse the Issuing Bank with respect to the Issuing Bank's honoring a draw under an LC render the Company \"insolvent.\" For the purposes of this Section 6.15, a corporation is \"insolvent\" if (i) the \"present fair salable value\" (as defined below) of its assets is less than the amount that will be required to pay its probable liability on its existing debts and other liabilities (including contingent liabilities) as they become absolute and matured; (ii) the property of the Company constitutes unreasonably small capital for the Company to carry out its business as now conducted and as proposed to be conducted including the capital needs of the Company; (iii) the Company intends to, or believes that it will, incur debts beyond its ability to pay such debts as they mature (taking into account the timing and amounts of cash to be received by the Company and amounts to be payable on or in respect of debt of the Company), or the cash available to the Company after taking into account all other anticipated uses of the cash of the Company is anticipated to be insufficient to pay all such amounts on or in respect of debt of the Company when such amounts are required to be paid; or (iv) the Company believes that final judgments against the Company in actions for money damages will be rendered at a time when, or in an amount such that, the Company will be unable to satisfy any such judgments promptly in accordance with their terms (taking into account the maximum reasonable amount of such judgments in any such actions and the earliest reasonable time (as determined in the Company's best judgment) at which such judgments might be rendered), or the cash available to the Company after taking into account all other anticipated uses of the cash of the Company (including the payments on or in respect of debt referred to in clause (iii) of this Section 6.15), is anticipated to be insufficient to pay all such judgments promptly in accordance with their terms. For purposes of this Section 6.15, the following terms have the following meanings: (x) the term \"debts\" includes any legal liability, whether matured or unmatured, liquidated, absolute, fixed or contingent, (y) the term \"present fair salable value\" of the Company's assets means the amount which may be realized, within a reasonable time (as determined in the Company's best judgment), either through collection or sale of such assets at their regular market value and (z) the term \"regular market value\" means the amount which a capable and\ndiligent businessman (as determined in the Company's best judgment) could obtain for the property in question within a reasonable time (as determined in the Company's best judgment) from an interested buyer who is willing to purchase under ordinary selling conditions (as determined in the Company's best judgment).\nSECTION 6.16 Use of Proceeds. The Company will use the proceeds of any Loans for general corporate purposes, including but not limited to financing future acquisitions and future working capital needs, including transactions with Affiliates.\nSECTION 6.17 Subsidiaries. The Company has no Subsidiaries except as listed on Schedule 6.17 hereto.\nSECTION 7 COVENANTS\nUntil the expiration or termination of each Bank's Commitment and thereafter until all Liabilities of the Company are paid in full and all LCs have expired or been terminated, the Company agrees that, unless at any time the Majority Banks (except with respect to such sections that expressly require the written consent of all of the Banks) shall otherwise expressly consent in writing, it will:\nSECTION 7.1 Reports, Certificates and Other Information. Furnish to the Agent, the Issuing Bank and each of the Banks:\n(a) Annual Report. On or before the ninetieth (90th) day after each of the Company's fiscal years, a copy of an unqualified annual consolidated audit report of the Company and its Subsidiaries, prepared in conformity with GAAP, duly certified by independent certified public accountants of recognized standing selected by the Company.\n(b) Interim Reports. On or before the forty-fifth (45th) day after the end of each of the first three quarters of each fiscal year of the Company, a copy of the unaudited financial statements of the Company prepared in a manner consistent with the financial statements referred to in Section 7.1(a) hereof, signed by an Authorized Officer and consisting of, at least, balance sheets as at the close of such quarter and statements of earnings for such quarter and for the period from the beginning of such fiscal year to the close of such quarter.\n(c) Statutory Statements. Promptly upon the filing thereof, copies of all Statutory Statements required to be filed by the Company and each Principal Insurance Subsidiary with or to the insurance commission or department of such Person's respective state of domicile.\n(d) Reports to SEC. Promptly upon the filing or making thereof, copies of each Form 10-K and Form 10-Q made by the Company with or to the Securities and Exchange Commission.\n(e) Certificates. Simultaneously with the furnishing of each annual statement and each quarterly statement provided for in this Section 7.1, a certificate of an Authorized Officer stating that (i) no Event of Default has occurred and is continuing, or, if there is any such event, setting forth the details thereof and the action that the Company is taking or proposes to take with respect thereto and (ii) that the Company either has funds or investments or has the ability to promptly obtain funds from its Subsidiaries, including, without limitation, by means of inter-corporate loans or advances from such Subsidiaries, dividends or other distributions from such Subsidiaries or purchases by such Subsidiaries of stock, other securities or assets of, or fees for services that are due and payable from, other Subsidiaries of the Company, in an amount not less than the sum of (A) the amount of all principal of and interest on all Loans outstanding, (B) the Aggregate Stated Amount of all LCs issued and outstanding and (C) the aggregate amount of all Reimbursement Obligations, and that the ability of the Company to promptly obtain such funds will not violate or result in the breach of any law, rule, regulation or order of any governmental authority (federal, state, local or foreign and including, without limitation, Insurance Laws).\n(f) Notice of Default, Litigation and ERISA Matters. Promptly upon learning of the occurrence of any of the following, written notice thereof which describes the same and the steps being taken by the Company with respect thereto: (i) the occurrence of an Event of Default, (ii) the institution of, or any adverse determination in, any litigation, arbitration proceeding or governmental proceeding in which any injunctive relief is sought or in which money damages in excess of $5,000,000 are sought, (iii) the occurrence of a material Reportable Event with respect to any Plan subject to Title IV of ERISA, (iv) the institution of any material steps by the Company, the PBGC or any other Person to terminate any Plan subject to Title IV of ERISA, (v) the institution of any material steps by the Company or any ERISA Affiliate to withdraw from any Plan subject to Title IV of ERISA which would result in material liability to the Company, (vi) the failure to make a material required contribution to any Plan if such failure is sufficient to give rise to a lien under Section 302(f) of ERISA, (vii) the taking of any material action with respect to a Plan which could result in the requirement that the Company furnish a bond or other security to the PBGC or such Plan, (viii) the occurrence of any event with respect to any Plan which could result in the incurrence by the Company of any liability, fine or penalty, which would in the Company's determination materially and adversely affect the Company's business, operations or financial condition or the ability of the Company to perform its obligations hereunder and under the Related Documents to which it is a party, or (ix) promptly after the incurrence thereof, notice of any material increase in the contingent liability of the Company with respect to any postretirement Plan benefits.\n(g) Other Information. Such other material information concerning the Company as the Agent, the Issuing Bank or any Bank may reasonably request from time to time.\nSECTION 7.2 Corporate Existence and Franchises. Except\nas otherwise expressly permitted in this Agreement, maintain and cause each Material Subsidiary to maintain in full force and effect its separate existence and all rights, licenses, leases and franchises reasonably necessary in the Company's sole discretion to the conduct of its and each Material Subsidiary's business.\nSECTION 7.3 Books, Records and Inspections. Maintain, and cause each Material Subsidiary to maintain, books and records in accordance with GAAP in all material respects, the Agent on behalf of the Banks to have access to the Company's books and records, and permit the Agent on behalf of the Banks, upon seven (7) days notice to the Company, to inspect the Company's properties and operations during normal business hours and at reasonable intervals, but no more frequently than semi-annually if no Event of Default has occurred.\nSECTION 7.4 Insurance. Maintain, and cause each Material Subsidiary to maintain, such insurance as may be required by law.\nSECTION 7.5 Taxes and Liabilities. Promptly pay, and cause each Material Subsidiary to pay, when due all taxes, duties, assessments and other liabilities (except such taxes, duties, assessments and other liabilities as the Company or such Material Subsidiary is diligently contesting in good faith and by appropriate proceedings; provided that the Company or such Material Subsidiary has provided for and is maintaining adequate reserves with respect thereto in accordance with GAAP), a failure of which to pay in the Company's determination materially and adversely affects the Company's or such Material Subsidiary's business, operations or financial condition or the Company's ability to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 7.6 Cash Flow Coverage. Maintain a ratio of (x) Available Cash Flow to (y) Debt Service Requirements equal to or greater than 1.10 to 1 at the end of each fiscal quarter of the Company and its Subsidiaries on a consolidated basis, such ratio to be calculated for the period of the four fiscal quarters ending on the most recent fiscal quarter end prior to the date of computation.\nSECTION 7.7 Net Worth. Nor permit the Net Worth of the Company to be less than $60,000,000 at any time.\nSECTION 7.8 Funds for Refinancing. Shall, at all times, either have funds or investments or have the ability to promptly obtain funds from its Subsidiaries, including, without limitation, by means of inter- corporate loans or advances from such Subsidiaries, dividends or other distributions from such Subsidiaries or purchases by such Subsidiaries of stock, other securities or assets of, or fees for services that are due and payable from, other Subsidiaries of the Company, in an amount at all times not less than the sum of (a) the amount of all principal of and interest on all Loans outstanding, (b) the Aggregate Stated Amount of all LCs issued and outstanding and (c) the aggregate amount of all Reimbursement Obligations, and the ability of the Company to promptly obtain such funds shall not violate or result in the breach of any law, rule, regulation or\norder of any governmental authority (federal, state, local or foreign and including, without limitation, Insurance Laws).\nSECTION 7.9 Indebtedness. Not incur or permit to exist any Indebtedness that by its terms or otherwise is senior in right of payment to the Liabilities, except (i) Indebtedness hereinafter incurred in connection with the acquisition of assets or property, which Indebtedness is secured by the assets or property so acquired, (ii) Indebtedness originally incurred under this Agreement and converted into term loan Indebtedness pursuant to such terms and subject to such documentation as is satisfactory to the Agent and the Majority Banks in such Majority Banks' reasonable discretion (provided, however, that no Bank shall, without its consent, be compelled to convert any Indebtedness owed to it and originally incurred under this Agreement into term loan Indebtedness) and (iii) Indebtedness in connection with Permitted Liens pursuant to Section 7.16.\nSECTION 7.10 Risk-Based Capital. Shall cause each Principal Insurance Subsidiary on an individual basis to maintain at all times Total Adjusted Capital equal to or greater than 260% of Authorized Control Level RBC.\nSECTION 7.11 Real Estate Concentration. Shall cause each Principal Insurance Subsidiary on an individual basis to maintain at all times a Real Estate Concentration Ratio of less than 50%.\nSECTION 7.12 Investment Quality. Shall cause each Principal Insurance Subsidiary on an individual basis to maintain at all times a ratio of (x) Non-Investment Grade Obligations to (y) Total Invested Assets to be less that 15%.\nSECTION 7.13 Intentionally Omitted.\nSECTION 7.14 Insurance Company Leverage Ratio. Shall cause (a) all Principal Insurance Subsidiaries on a combined basis to maintain at all times an aggregate Insurance Company Leverage Ratio of greater than 8.33%, and (b) each Principal Insurance Subsidiary on an individual basis to maintain at all times an Insurance Coverage Leverage Ratio of greater than 7.50%.\nSECTION 7.15 Intentionally Omitted.\nSECTION 7.16 Negative Pledge. Shall not permit any Principal Insurance Subsidiary to (a) create or permit to exist any Lien with respect to any assets or properties now owned or hereafter acquired by such Principal Insurance Subsidiary or (b) enter into or consent to any oral or written agreement or arrangement that prohibits or in any manner restricts any such Principal Insurance Subsidiary from creating, incurring, assuming or suffering to exist any Lien upon or with respect to any of such Principal Insurance Subsidiary's assets or properties or to assign or otherwise convey any right to receive income, except the following Liens (\"Permitted Liens\"): (i) purchase money security interests hereinafter incurred in connection with the acquisition of assets or property; (ii)\nLiens incurred in connection with the conversion of Indebtedness originally incurred under this Agreement into term loan Indebtedness pursuant to such terms and subject to such documentation as is satisfactory to the Agent and the Majority Banks in such Majority Banks' reasonable discretion (provided, however, that no Bank shall, without its consent, be compelled to convert any Indebtedness owed to it and originally incurred under this Agreement into term loan Indebtedness); (iii) Liens for taxes, assessments or governmental charges or levies on property of the Company if the same shall not at the time be delinquent or thereafter can be paid without penalty, or are being contested in good faith and by appropriate proceedings and as to which the Company shall have set aside on its books such reserves as are required by GAAP with respect to any such taxes, assessments or other governmental charges; (iv) Liens imposed by law, such as carriers', warehousemen's and mechanics' liens and other similar liens, which arise in the ordinary course of business with respect to obligations not yet due or being contested in good faith by appropriate proceedings and as to which the Company shall have set aside on its books such reserves as are required by GAAP with respect to any such Liens; (v) Liens arising out of pledges or deposits under insurance laws, worker's compensation laws, unemployment insurance, old age pensions, or other Social Security or retirement benefits, or similar legislation; (vi) Liens consisting of mortgages, deeds of trust, liens or security interests on any interest of the Company as sublessor under any sublease of property which solely secure obligations of the Company as the lessee of such property and extensions or renewals thereof; and (vii) Liens consisting of mortgages, deeds of trust or similar encumbrances that may be incurred by the Company or an Insurance Subsidiary of the Company in connection with the Company's or such Insurance Subsidiary's purchase or refinancing of the building and property located at 1750 Golf Road, Schaumburg, Illinois; provided, however, that promptly after the creation of any Lien of the type referred to in this subsection (vii), the Company shall provide to the Agent written notice of the creation of such Lien, describing the amount of the obligation secured thereby and the properties and assets subject to such Lien.\nSECTION 7.17 Change in Nature of Business. Not, and not permit the Company and its Material Subsidiaries as a whole to, make any material change in the nature of its business carried on as of the date first stated above, provided, however, the Company or any Material Subsidiary may make changes in the nature of its business provided that any such change made is related in any way to the medical or insurance businesses.\nSECTION 7.18 Depository Relationship. The Company shall maintain its primary depository and remittance relationship with the Banks. Pursuant to such primary depository and remittance relationship, the Company shall maintain with each Bank average available demand deposits equal to the amount needed to cover non-credit services provided by such Bank to the Company and its Subsidiaries, such amount to be determined according to the published fee schedules of such Bank. The Company agrees that if the amount of available demand deposits maintained by the Company with such Bank are insufficient to equal the amount needed to cover non- credit services provided by such Bank, then such Bank may charge the Company a deficiency fee sufficient to cover such non-credit services, such\ndeficiency fee to be determined according to the published fee schedules of such Bank or the fees being charged to the Company at that time, whichever are less.\nSECTION 7.19 Employee Benefit Plans. Not permit, and not permit any ERISA Affiliate to permit, any condition to exist in connection with any Plan which might constitute grounds for the PBGC to institute proceedings to have such Plan terminated or a trustee appointed to administer such Plan; and not engage in, or permit to exist or occur, or permit any ERISA Affiliate to engage in, or permit to exist or occur, any other condition, event or transaction with respect to any Plan which would result in the incurrence by the Company or any ERISA Affiliate of any liability, fine or penalty, which in either case would in the Company's determination materially and adversely affect the Company's business, operations or financial condition, or the ability of the Company to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 7.20 Use of Proceeds. Not, and not permit any Subsidiary to, use or permit the direct or indirect use of any proceeds of or with respect to any Loan for the purpose, whether immediate, incidental or ultimate, of \"purchasing or carrying\" (within the meaning of Regulation U) Margin Stock.\nSECTION 7.21 Other Agreements. Not, and not permit any Material Subsidiary to, enter into any agreement containing any provision which would be violated or breached by the performance of the Company's obligations hereunder, under any Related Document or under any instrument or document delivered or to be delivered by the Company hereunder or thereunder or in connection herewith or therewith or which would violate or breach any provision hereof or thereof or of any such instrument or document.\nSECTION 7.22 Compliance with Applicable Laws. Comply, and cause each Material Subsidiary to comply, with the requirements of all applicable laws, rules, regulations, and orders of all governmental authorities (Federal, state, local or foreign, and including, without limitation, Environmental Laws and Insurance Laws), a breach of which would in the Company's determination materially and adversely affect the Company's or such Material Subsidiary's business, operations or financial condition, or which would impair the Company's ability to perform its obligations hereunder and under the Related Documents to which it is a party.\nSECTION 7A UNRESTRICTED SUBSIDIARIES\nSECTION 7A.1 Unrestricted Subsidiaries. The Company may, from time to time, by written notice to the Agent, a copy of which the Agent shall promptly deliver to each Bank, designate a Subsidiary as an Unrestricted Subsidiary (referred to herein as an \"Unrestricted Subsidiary\") provided that each of the following conditions is satisfied:\n(a) the proposed Unrestricted Subsidiary shall not be a Material Subsidiary existing on the Closing Date;\n(b) the aggregate Indebtedness of all Unrestricted Subsidiaries, including the Indebtedness of the proposed Unrestricted Subsidiary, shall not exceed $40,000,000;\n(c) If Loans made to the Company under this Agreement were used by the Company directly or indirectly to acquire the proposed Unrestricted Subsidiary, such Loans shall have been repaid by the Company pursuant to the terms hereof;\n(d) the proposed Unrestricted Subsidiary shall have no financial obligations, liabilities or dealings of any kind with the Company or any Material Subsidiary of the Company, except for (i) ordinary overhead allocations, (ii) marketing agreements, administration agreements and other agreements which the Company customarily enters into with its Subsidiaries so long as the terms of such agreements are no more favorable to the Company than the terms of agreements the Company enters into with its other Subsidiaries, and (iii) other customary inter-corporate dealings so long as the terms of such dealings are no more favorable to the Company than the terms of dealings the Company enters into with its other Subsidiaries; and\n(e) the proposed Unrestricted Subsidiary shall not have, permit to exist or incur any undertaking, indebtedness, obligation or other liability pursuant to which recourse may be made to the Company or any Material Subsidiary of the Company, and neither the Company nor any Material Subsidiary of the Company shall be or become a guarantor or surety of, or otherwise be or become responsible in any manner (whether by support agreement or agreement to purchase any obligations, stock, assets, goods or services, or to supply or advance any funds, assets, goods or services, or otherwise) with respect to any undertaking, indebtedness, obligation or other liability of such proposed Unrestricted Subsidiary; provided, however, that the proposed Unrestricted Subsidiary shall be permitted to engage in the types of transactions prohibited by this Section 7A.1(e), and the Company shall be permitted to provide guarantees and sureties, if the Company's obligations under such transactions, guaranties and sureties (i) are expressly subordinated to the Company's obligations under this Agreement and (ii) shall not exceed $2,000,000 in the aggregate for any one Unrestricted Subsidiary.\nSECTION 7A.2 Additional Unrestricted Subsidiaries. In addition to the Unrestricted Subsidiaries designated pursuant to Section 7A.1 above, the Company and the Majority Banks can agree to designate any Subsidiary as an Unrestricted Subsidiary. Any Indebtedness of an Unrestricted Subsidiary designated as such pursuant to this Section 7A.2 shall be excluded from the calculation of the aggregate Indebtedness permitted pursuant to Section 7A.1.\nSECTION 7A.3 Effectiveness of Designation. The designation by the Company of a Subsidiary as an Unrestricted Subsidiary shall become effective five (5) Business Days after the Company delivers a written\nnotice of such designation to the Agent, which notice shall certify that all of the conditions set forth in Section 7A.1 have been satisfied with respect to such Unrestricted Subsidiary. The Agent shall promptly deliver to each Bank a copy of such notice.\nSECTION 7A.4 Effect of Designation. Other than for purposes of the financial statements referenced in Section 7.1 hereof, the assets, liabilities, Indebtedness, income, losses, cash flow, net worth, liens and other relevant amounts and factors concerning any Unrestricted Subsidiary shall be excluded from the computations referenced in Sections 7.6 and 7.9 of this Agreement and, to the extent applicable, the computations referenced in Sections 7.10 through 7.16, inclusive, of this Agreement, and the Unrestricted Subsidiaries shall not be subject to any of the other limitations or restrictions contained herein.\nSECTION 8 CONDITIONS TO MAKING LOANS AND ISSUING LCS\nEach Bank's obligation to make any Loan and the Issuing Bank's obligation to issue any LC is subject to the satisfaction of each of the following conditions precedent:\nSECTION 8.1 Initial Loans. Each Bank's obligation to make its initial Loan and the Issuing Bank's obligation to issue its initial LC is, in addition to the conditions precedent specified in Section 8.2, subject to the satisfaction of each of the following conditions precedent:\n(a) Fees and Expenses. The Company shall have paid all fees owed to the Agent, the Issuing Bank and each of the Banks and reimbursed the Agent, the Issuing Bank and each of the Banks for all expenses due and payable hereunder on or before the Closing Date including, but not limited to, ANB's counsel fees provided for in Section 10.4 to the extent such counsel shall have requested payment of such fees.\n(b) Documents. The Agent shall have received in sufficient copies for the Issuing Bank and each of the Banks all of the following, each duly executed and delivered and dated the Closing Date, in form and substance satisfactory to the Agent, the Issuing Bank and each Bank:\n(i) Agreement. This Agreement, executed by the Company, the Agent and each Bank.\n(ii) Note. Promissory Notes, substantially in the form of Exhibit A hereto, with appropriate insertions, issued to each Bank and executed by the Company.\n(iii) Resolutions. Certified copies of resolutions of the Company's Board of Directors authorizing the execution, delivery and performance of this Agreement and the Related Documents to which the Company is a party and any other documents provided for herein or therein to be executed by the Company.\n(iv) Consents. Certified copies of all documents evidencing any necessary corporate action, consents and governmental approvals, if any, with respect to this Agreement, the Related Documents, and any other documents provided for herein or therein to be executed by the Company.\n(v) Incumbency and Signatures. A certificate of the Secretary or an Assistant Secretary of the Company certifying the names of the officer or officers of the Company authorized to sign this Agreement and the Related Documents to which the Company is a party and any other documents provided for herein or therein to be executed by the Company, together with a sample of the true signature of each such officer. Each Bank may conclusively rely on each such certificate until formally advised by a like certificate of any changes therein.\n(vi) Opinion of Counsel. Opinion of counsel to the Company in form and substance reasonably satisfactory to the Agent.\n(vii) Constitutive Documents. Certified copies of the Company's articles of incorporation and by-laws.\n(viii) Good Standing Certificates. Certificates of good standing for the Company in Delaware and Illinois and a certificate of the insurance commissioner or similar official of the jurisdiction of incorporation of each Principal Insurance Subsidiary as to the good standing of such Principal Insurance Subsidiary.\n(ix) Other. Such other documents as the Agent, the Issuing Bank or any Bank may reasonably request.\nSECTION 8.2 All Loans and LCs. Each Bank's obligation to make its initial Loan and each subsequent Loan, including the obligation of such Bank to convert or continue any Loan pursuant to Section 2.4 hereof, and the Issuing Bank's obligation to issue the initial LC and each subsequent LC, or any extension or amendment thereof, is subject to the following conditions precedent that:\n(a) No Default, etc. (i) No Event of Default shall have occurred and be continuing or will result from the making of such Loan or the issuance of such LC, and (ii) the Company's representations and warranties contained in Section 6 shall be true and correct as of the date of such requested Loan or LC with the same effect as though made on the date thereof (except to the extent such representations and warranties expressly refer to an earlier date, in which case they shall be true and correct as of such earlier date).\n(b) Notice. The Agent shall have received a Notice of Borrowing pursuant to and in accordance with the provisions of Section 2.3 hereof or a Notice of Conversion/Continuation pursuant to and in accordance with the\nprovisions of Section 2.4 hereof, as the case may be.\nSECTION 9 EVENTS OF DEFAULT AND THEIR EFFECT\nSECTION 9.1 Events of Default. Each of the following shall constitute an Event of Default under this Agreement following the expiration of any applicable notice or cure period:\n(a) Nonpayment of the Loan. Default in the payment when due of the principal of or interest on any Loan, or the payment when due of any fees or any other amounts payable by the Company hereunder and continuance of such default for five (5) Business Days after the applicable due date.\n(b) Nonpayment of Other Indebtedness. Default in the payment when due (subject to any applicable grace period), whether by acceleration or otherwise, of any other Indebtedness of, or guaranteed by, the Company or any Material Subsidiary if the aggregate amount of any such other Indebtedness that is accelerated or due and payable, or that may be accelerated or otherwise become due and payable, by reason of such default is $5,000,000 or more, or default in the performance or observance of any obligation or condition with respect to any such other Indebtedness if the effect of such default is to accelerate the maturity of any such Indebtedness or cause any of such Indebtedness of $5,000,000 or more to be prepaid, purchased or redeemed or to permit the holder or holders thereof, or any trustee or agent for such holders, to cause such Indebtedness of $5,000,000 or more to become due and payable prior to its expressed maturity or to cause such Indebtedness of $5,000,000 or more to be prepaid, purchased or redeemed.\n(c) Bankruptcy or Insolvency. The Company becomes insolvent or generally fails to pay, or admits in writing its general inability to pay, debts as they become due; or the Company applies for, consents to, or acquiesces in the appointment of, a trustee, receiver or other custodian for the Company, or any property thereof, or makes a general assignment for the benefit of creditors; or, in the absence of such application, consent or acquiescence, a trustee, receiver or other custodian is appointed for the Company or for a substantial part of the property thereof and is not discharged within 60 days; or any bankruptcy, reorganization, debt arrangement, or other case or proceeding under any bankruptcy or insolvency law, or any dissolution or liquidation proceeding, is commenced in respect of the Company, and if such case or proceeding is not commenced by the Company, it is consented to or acquiesced in by the Company or remains for 60 days undismissed; or the Company takes any corporate action to authorize, or in furtherance of, any of the foregoing or the insurance commission or department of any Principal Insurance Subsidiary's state of domicile takes any action against such Principal Insurance Subsidiary or the Company in connection with any of the foregoing.\n(d) Specified Noncompliance with this Agreement. Failure by the Company to comply with or to perform under Section 7.2 (only with respect\nto the maintenance of the existence of the Company), Sections 7.6 through 7.16, inclusive, and Section 7.21 hereunder and continuance of such failure for five (5) Business Days after (i) written notice thereof to the Company from the Agent or (ii) any Authorized Officer of the Company knew or should have known of such failure to comply or perform; provided, however, that, with respect to the failure by the Company to comply with or to perform under Sections 7.10 through 7.14, inclusive, the continuance of such failure shall be extended from five (5) Business Days to thirty (30) days if the Agent receives written notice from the Company prior to the expiration of such five (5) Business Day period that such failure is curable within such thirty (30) day period.\n(e) Other Noncompliance with this Agreement. Failure by the Company to comply with or to perform any provision of this Agreement (and not constituting an Event of Default under any of the other provisions of this Section 9) and continuance of such failure for sixty (60) days after (i) written notice thereof to the Company from the Agent or (ii) any Authorized Officer of the Company knew of such failure to comply or perform.\n(f) Representations and Warranties. Any representation or warranty made by the Company herein or in any Related Document is breached in any material respect or is known by the Company to have been false or misleading in any material respect when given, or any schedule, certificate, financial statement, report, notice, or other writing furnished by the Company to the Agent, the Issuing Bank or any Bank is known by the Company to have been false or misleading in any material respect on the date as of which the facts therein set forth are stated or certified.\n(g) Employee Benefit Plans. (i) Institution by the PBGC, the Company or any ERISA Affiliate of steps to terminate a Plan subject to Title IV of ERISA if as a result of such termination, the Company or any ERISA Affiliate would be required to make a material contribution to such Plan, or would incur a material liability or obligation to such Plan; (ii) occurrence of a contribution failure with respect to any Plan sufficient to give rise to a lien under Section 302(f) of ERISA, or (iii) incurrence of any material liability (including current or potential withdrawal liability) by the Company or any ERISA Affiliate with respect to any Multiemployer Plan.\n(h) Judgments. There shall be entered against the Company one or more final unappealable judgments or decrees in excess of $5,000,000 in the aggregate at any one time outstanding for the Company, excluding those judgments or decrees (i) that shall have been stayed, vacated or bonded, (ii) that shall have been outstanding less than 30 days from the entry thereof, (iii) for and to the extent to which the Company is insured and with respect to which the insurer specifically has determined that it shall assume responsibility in writing or (iv) for and to the extent to which the Company is otherwise indemnified if the terms of such indemnification are satisfactory to the Majority Banks.\nSECTION 9.2 Effect of Event of Default. If any Event of Default described in Section 9.1(c) shall occur, the Commitments (if they have not theretofore terminated) shall immediately terminate and all Loans, the Notes and all other Liabilities shall become immediately due and payable, all without presentment, demand or notice of any kind, all of which, except as expressly set forth herein, are hereby expressly waived by the Company; and, in the case of any other Event of Default, the Agent shall, at the request of, or may, with the consent of, the Majority Banks, by written notice to the Company, declare the Commitments (if they have not theretofore terminated) to be terminated and all Loans, the Notes and all other Liabilities to be due and payable, whereupon such Loans, the Notes and all other Liabilities shall become immediately due and payable, all without presentment, demand or notice of any kind, all of which, except as expressly set forth herein, are hereby expressly waived by the Company.\nSECTION 9A THE AGENT\nSECTION 9A.1 Appointment and Authorization. Each Bank hereby appoints, designates and authorizes the Agent to take such action on its behalf under the provisions of this Agreement and each other Related Document and to exercise such powers and perform such duties as are expressly delegated to it by the terms of this Agreement or any other Related Document, together with such powers as are reasonably incidental thereto. Notwithstanding any provision to the contrary contained elsewhere in this Agreement or in any other Related Document, the Agent shall not have any duties or responsibilities, except those expressly set forth herein, nor shall the Agent have or be deemed to have any fiduciary relationship with any Bank, and no implied covenants, functions, responsibilities, duties, obligations or liabilities shall be read into this Agreement or any other Related Document or otherwise exist against the Agent.\nSECTION 9A.2 Delegation of Duties. The Agent may execute any of its duties under this Agreement or any other Related Document by or through agents, employees or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. The Agent shall not be responsible for the negligence or misconduct of any agent or attorney-in-fact that it selects with reasonable care.\nSECTION 9A.3 Liability of Agent. None of the Agent-Related Persons shall (i) be liable to any Bank for any action taken or omitted to be taken by any of them under or in connection with this Agreement or any other Related Document (except for its own gross negligence or willful misconduct) or (ii) be responsible in any manner to any of the Banks for any recital, statement, representation or warranty made by the Company or any officer thereof contained in this Agreement or in any other Related Document, or in any certificate, report, statement or other document referred to or provided for in, or received by the Agent under or in connection with, this Agreement or any other Related Document, or the validity, effectiveness, genuineness, enforceability or sufficiency of this\nAgreement or any other Related Document, or for any failure of the Company to perform its obligations hereunder or under any Related Document. No Agent-Related Person shall be under any obligation to any Bank to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any other Related Document, or to inspect the properties, books or records of the Company or any of the Company's Subsidiaries or Affiliates.\nSECTION 9A.4 Reliance by Agent.\n(a) The Agent shall be entitled to rely, and shall be fully protected in relying, upon any writing, resolution, notice, consent, certificate, affidavit, letter, telegram, facsimile, telex or telephone message, statement or other document or conversation believed by it to be genuine and correct and to have been signed, sent or made by the proper Person or Persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by the Agent. The Agent shall be fully justified in failing or refusing to take any action under this Agreement or any other Related Document unless it shall first receive such advice or concurrence of the Majority Banks as it deems appropriate and, if it so requests, it shall first be indemnified to its satisfaction by the Banks (to the extent not indemnified by the Company) against any and all liability and expense that may be incurred by it by reason of taking or continuing to take any such action. The Agent shall in all cases be fully protected in acting, or in refraining from acting, under this Agreement or any other Related Document in accordance with a request or consent of the Majority Banks (or, when expressly required hereby, all the Banks) and such request and any action taken or failure to act pursuant thereto shall be binding upon all of the Banks.\n(b) For purposes of determining compliance with the conditions specified in Section 8.1, each Bank that has executed this Agreement shall be deemed to have consented to, approved or accepted or to be satisfied with each document or other matter either sent by the Agent to such Bank for consent, approval, acceptance or satisfaction, or required thereunder to be consented to or approved by or acceptable or satisfactory to such Bank.\nSECTION 9A.5 Notice of Default. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Event of Default, except with respect to defaults in the payment of principal, interest and fees required to be paid to the Agent for the account of the Banks, unless the Agent shall have received written notice from a Bank or the Company referring to this Agreement, describing such Event of Default and stating that such notice is a \"notice of default\". In the event that the Agent receives such a notice, the Agent shall promptly give notice thereof to the Banks. The Agent shall take such action with respect to such Event of Default as shall be requested by the Majority Banks in accordance with Section 9; provided, however, that unless and until the Agent shall have received any such request, the Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Event of Default as it shall deem advisable or in the best interest of the\nBanks.\nSECTION 9A.6 Credit Decision. Each Bank expressly acknowledges that none of the Agent-Related Persons has made any representation or warranty to it and that no act by the Agent hereinafter taken, including any review of the affairs of the Company and its Subsidiaries shall be deemed to constitute any representation or warranty by the Agent to any Bank. Each Bank represents to the Agent that it has, independently and without reliance upon the Agent and based on such documents and information as it has deemed appropriate, made its own appraisal of and investigation into the business, prospects, operations, property, financial and other condition and creditworthiness of the Company and its Subsidiaries, and all applicable bank regulatory laws relating to the transactions contemplated thereby, and made its own decision to enter into this Agreement and extend credit to the Company hereunder. Each Bank also represents that it will, independently and without reliance upon the Agent and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit analysis, appraisals and decisions in taking or not taking action under this Agreement and the other Related Documents, and to make such investigations as it deems necessary to inform itself as to the business, prospects, operations, property, financial and other condition and creditworthiness of the Company and its Subsidiaries. Except for notices, reports and other documents expressly herein required to be furnished to the Banks by the Agent, the Agent shall not have any duty or responsibility to provide any Bank with any credit or other information concerning the business, prospects, operations, property, financial and other condition or creditworthiness of the Company and its Subsidiaries that may come into the possession of any of the Agent-Related Persons.\nSECTION 9A.7 Indemnification. Whether or not the transactions contemplated hereby shall be consummated, the Banks shall indemnify upon demand the Agent-Related Persons (to the extent not reimbursed by or on behalf of the Company and without limiting the obligation of the Company to do so), ratably from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses and disbursements of any kind whatsoever that may at any time (including at any time following the repayment of the Loans and reimbursement of the LCs and the termination or resignation of the related Agent) be imposed on, incurred by or asserted against any such Person in any way relating to or arising out of this Agreement or any document contemplated by or referred to herein or the transactions contemplated hereby or any action taken or omitted by any such Person under or in connection with any of the foregoing; provided, however, that no Bank shall be liable for the payment to any Agent-Related Person of any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from any Agent-Related Person's gross negligence or willful misconduct. Without limitation of the foregoing, each Bank shall reimburse the Agent upon demand for its ratable share of any costs or out-of-pocket expenses (including attorney costs) incurred by the Agent in connection with the administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise)\nof, or legal advice in respect of rights or responsibilities under, this Agreement, any other Related Document, or any document contemplated by or referred to herein to the extent that the Agent is not reimbursed for such expenses by or on behalf of the Company. The obligation of the Banks in this Section shall survive the payment of all Obligations hereunder.\nSECTION 9A.8 Agent in Individual Capacity. ANB and its Affiliates may make loans to, issue letters of credit for the account of, accept deposits from, acquire equity interests in and generally engage in any kind of banking, trust, financial advisory or other business with the Company and its Subsidiaries and Affiliates as though ANB were not the Agent hereunder and without notice to or consent of the Banks. With respect to its Loans, ANB shall have the same rights and powers under this Agreement as any other Bank and may exercise the same as though it were not the Agent, and the terms \"Bank\" and \"Banks\" shall include ANB in its individual capacity.\nSECTION 9A.9 Successor Agent. The Agent may resign as Agent upon 30 days' notice to each of the Banks and the Company. If the Agent shall resign as Agent under this Agreement, the Majority Banks shall appoint from among the Banks a successor agent for the Banks which successor agent shall be approved by the Company, which consent shall not be unreasonably withheld. If no successor agent is appointed prior to the effective date of the resignation of the Agent, the Agent may appoint, after consulting with the Banks and the Company, a successor agent from among the Banks. Upon the acceptance of its appointment as successor agent hereunder, such successor agent shall succeed to all the rights, powers and duties of the retiring Agent and the term \"Agent\" shall mean such successor agent and the Agent's appointment, powers and duties as Agent shall be terminated. After any retiring Agent's resignation hereunder as Agent, the provisions of this Section 9A and Sections 10.4 and 10.5 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under this Agreement. Notwithstanding the foregoing, the Agent's resignation shall not be effective until a successor agent is appointed and such successor agent accepts such appointment as successor agent hereunder.\nSECTION 10 GENERAL\nSECTION 10.1 Amendments and Waivers. No amendment or waiver of any provision of this Agreement or any other Related Document, and no consent with respect to any departure by the Company therefrom, shall be effective unless the same shall be in writing and signed by the Majority Banks, acknowledged by the Agent, and, in the case of amendments, signed by the Company, and then any such waiver shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no such waiver, amendment, or consent shall, unless in writing and signed by all the Banks, acknowledged by the Agent, and, in the case of an amendment, signed by the Company, do any of the following:\n(a) increase or extend the Commitment of any Bank (or reinstate\nany Commitment terminated pursuant to Section 2.9) or subject any Bank to any additional obligations;\n(b) postpone or delay any date fixed for any payment of principal, interest, fees or other amounts due to the Banks (or any of them) hereunder or under any other Related Document;\n(c) reduce the principal of, or the rate of interest specified herein on any Loan, or of any fees or other amounts payable hereunder or under any other Related Document;\n(d) change the percentage of the Commitments which shall be required for the Banks or any of them to take action hereunder; or\n(e) amend this Section 10.1 or any provision providing for consent or other action by all Banks; and, provided further, that no amendment, waiver or consent shall, unless in writing and signed by the Agent in addition to the Majority Banks or all the Banks, as the case may be, affect the rights or duties of the Agent under this Agreement or any other Related Document.\nSECTION 10.2 Notices. All notices hereunder shall be in writing. Notices given by mail shall be deemed to have been given (i) five Business Days after the date sent if sent by registered or certified mail, postage prepaid, (ii) the next Business Day if sent by overnight delivery service, (iii) the day sent if sent by telecopy or telex if sent prior to 5:00 p.m. local time on a Business Day, otherwise the following day, or (iv) the day delivered if sent by personal messenger, and:\n(a) if to the Company, addressed to the Company at its address shown below its signature hereto;\n(b) if to the Agent, addressed to the Agent at the address shown below its signature hereto; or\n(c) if to a Bank, addressed to such Bank at the address shown below its signature hereto;\nor in the case of any party, such other address as such party, by written notice received by the other parties to this Agreement, may have designated as its address for notices.\nSECTION 10.3 Accounting Terms; Computations. All accounting terms used herein and not expressly defined in this Agreement shall have the respective meanings given to them in accordance with GAAP as in effect on the Closing Date. Where the character or amount of any asset or liability or item of income or expense is required to be determined, or any consolidation or other accounting computation is required to be made, for purposes of this Agreement such determination or calculation shall, to the extent applicable and except as otherwise specified in this Agreement or agreed to in writing by the Majority Banks, be made in accordance with GAAP as then in effect.\nSECTION 10.4 Costs, Expenses and Taxes.\n(a) The Company agrees to pay within thirty (30) days after demand by ANB (including in its capacity as Agent) all of ANB's (including in its capacity as Agent) reasonable out-of-pocket costs and expenses (including the reasonable fees and out-of-pocket expenses of ANB's counsel) in connection with the preparation, execution and delivery of this Agreement, the Related Documents and all other instruments or documents provided for herein or delivered or to be delivered hereunder or in connection herewith (including, without limitation, all amendments, supplements and waivers executed and delivered pursuant hereto or in connection herewith).\n(b) The reasonable costs and expenses which the Agent (on behalf of itself, the Issuing Bank and all other Banks) incurs in any manner or way with respect to the following shall be part of the Liabilities, payable by the Company within thirty (30) days after demand if at any time after the date of this Agreement the Agent (on behalf of itself, the Issuing Bank and all other Banks): (i) reasonably employs counsel for advice or other representation (A) to represent the Agent (on behalf of itself, the Issuing Bank and all other Banks) in any litigation, contest, dispute, suit or proceeding or to commence, defend or intervene or to take any other action in or with respect to any litigation, contest, dispute, suit or proceeding (whether instituted by the Agent, the Issuing Bank, such Bank, any other Bank, the Company or any other Person) in any way or respect relating to this Agreement or the Related Documents, (B) to enforce any of the Agent's, the Issuing Bank's or any such Bank's rights with respect to the Company under this Agreement and the Related Documents; and/ or (ii) reasonably seeks to enforce or enforces any of the Agent's, the Issuing Bank's or any such Bank's rights and remedies with respect to the Company under this Agreement and the Related Documents; provided, however, that notwithstanding the foregoing, if the interests of the Issuing Bank or any Bank conflict with the interests of such other Bank as determined by the Issuing Bank or such Bank, as the case may be, then the reasonable costs and expenses incurred by the Issuing Bank or such Bank, as the case may be, in respect of the foregoing shall be payable by the Company within thirty (30) days after demand by the Issuing Bank or such Bank, as the case may be.\n(c) All of the Company's obligations provided for in this Section 10.4 shall be Liabilities of the Company hereunder.\nSECTION 10.5 Indemnification. In consideration of the Agent's, the Issuing Bank's and each Bank's execution and delivery of this Agreement and each Bank's agreement to extend its Commitment and to make and maintain Loans and the Issuing Bank's commitment to issue LCs, the Company hereby agrees to indemnify, exonerate and hold the Agent, the Issuing Bank and each Bank and each of its officers, directors, employees and agents (herein collectively called the \"Bank Parties\" and individually called a \"Bank Party\") free and harmless from and against any and all actions, causes of action, suits, losses, costs (including, without limitation, all documentary or other stamp taxes or duties), liabilities and damages, and\nexpenses in connection therewith (irrespective of whether such Bank Party is a party to the action for which indemnification hereunder is sought) (the \"Indemnified Liabilities\"), including, without limitation, reasonable attorneys' fees and disbursements, incurred by such Bank Parties or any of them as a result of, or arising out of, or relating to (except for such Indemnified Liabilities arising on account of such Bank Party's gross negligence or willful misconduct):\n(a) any transaction financed or to be financed in whole or in part, directly or indirectly, with the proceeds of any Loan or LC;\n(b) the execution, delivery, performance, administration or enforcement of this Agreement and the Related Documents in accordance with their respective terms by any of such Bank Parties;\n(c) any misrepresentation or breach of any representation or warranty or covenant herein by the Company.\nIf and to the extent that the foregoing agreements described in this Section 10.5 may be unenforceable for any reason, the Company hereby agrees to make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law.\nSECTION 10.6 Captions and References. The recitals to this Agreement (except for definitions) and the section captions used in this Agreement are for convenience only, and shall not affect the construction of this Agreement.\nSECTION 10.7 No Waiver; Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of the Agent, the Issuing Bank or any Bank, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege.\nSECTION 10.8 Governing Law; Jury Trial; Severability. This Agreement and each Note shall be a contract made under and governed by the laws of the State of Illinois, without regard to conflict of laws principles. Wherever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under such law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement. All obligations of the Company and rights of the Agent, the Issuing Bank and any Bank, which obligations and rights are described herein or in the Note issued to such Bank, shall be in addition to and not in limitation of those provided by applicable law.\nTHE COMPANY HEREBY IRREVOCABLY WAIVES ANY RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING (i) TO ENFORCE OR DEFEND ANY RIGHTS UNDER OR IN CONNECTION WITH THIS AGREEMENT, THE RELATED DOCUMENTS, ANY LOAN, ANY LC OR\nANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR THEREWITH, OR (ii) ARISING FROM ANY DISPUTE OR CONTROVERSY IN CONNECTION WITH OR RELATED TO THIS AGREEMENT, THE RELATED DOCUMENTS, ANY LOAN, ANY LC, OR ANY SUCH AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT, AND AGREES THAT ANY SUCH ACTION OR COUNTERCLAIM SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY.\n____________________ Agreed and Acknowledged by the Company\nTHE COMPANY IRREVOCABLY AGREES THAT, SUBJECT TO THE AGENT'S, THE ISSUING BANK'S AND EACH BANK'S SOLE AND ABSOLUTE ELECTION, ANY ACTION OR PROCEEDING IN ANY WAY, MANNER OR RESPECT ARISING OUT OF THIS AGREEMENT, THE RELATED DOCUMENTS, ANY LOAN, ANY LC OR ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR THEREWITH, OR ARISING FROM ANY DISPUTE OR CONTROVERSY ARISING IN CONNECTION WITH OR RELATED TO THIS AGREEMENT, THE RELATED DOCUMENTS, ANY LOAN, ANY LC OR ANY SUCH AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT SHALL BE LITIGATED IN THE COURTS HAVING SITUS WITHIN THE CITY OF CHICAGO, THE STATE OF ILLINOIS, AND THE COMPANY HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURT LOCATED WITHIN SUCH CITY AND STATE. THE COMPANY HEREBY WAIVES ANY RIGHT IT MAY HAVE TO TRANSFER OR CHANGE THE VENUE OF ANY LITIGATION BROUGHT AGAINST THE COMPANY BY THE AGENT, THE ISSUING BANK OR ANY BANK IN ACCORDANCE WITH THIS SECTION 10.8.\nSECTION 10.9 Counterparts. This Agreement and any amendment or supplement hereto or any waiver or consent granted in connection herewith may be executed in any number of counterparts and by the different parties on separate counterparts and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same Agreement.\nSECTION 10.10 Successors and Assigns. Subject to Section 10.12, this Agreement shall be binding upon the Company, each Bank and their respective successors and assigns, and shall inure to the benefit of the Company, each Bank and each Bank's successors and assigns. The Company shall have no right to assign its rights or delegate its duties under this Agreement.\nSECTION 10.11 Prior Agreements. The terms and conditions set forth in this Agreement shall supersede all prior negotiations, agreements, discussions, correspondence, memoranda and understandings (whether written or oral) of the Company and the Agent, the Issuing Bank and any Bank concerning or relating to the subject matter of this Agreement (including, without limitation, the terms set forth in the proposal letter dated October 20, 1993 issued by the Banks to Mr. Peter W. Nauert).\nSECTION 10.12 Assignments; Participations. (a) Each Bank shall have the right to assign, with the written consent of the Company, which shall not be unreasonably withheld, to any Affiliate of such Bank and to one or more banks or other financial institutions, all or a portion of its rights\nand obligations under this Agreement (including, without limitation, all or a portion of its Commitment, the Loans, the LCs and the Note issued to such Bank) and the Related Documents. For purposes of this Section, it shall not be unreasonable for the Company to withhold its consent to a proposed assignee if, as a result of such proposed assignment, any one Bank's Commitment Percentage would be in excess of fifty percent (50%) or there would be more than six (6) banks or financial institutions party to this Agreement. Upon any such assignment, (x) the assignee shall become a party hereto and, to the extent of such assignment, have all rights and obligations of such Bank hereunder and under the Related Documents and (y) such Bank shall, to the extent of such assignment, relinquish its rights and be released from its obligations hereunder and under the Related Documents. The Company hereby agrees to execute and deliver such documents, and to take such other actions, as such Bank may reasonably request to accomplish the foregoing. Upon such assignment, this Agreement shall be deemed to be amended to the extent, but only to the extent, necessary to reflect the addition of the assignee and the resulting adjustment of the Commitments arising therefrom. The Commitment allocated to each assignee shall reduce such Commitment of the assigning Bank pro tanto.\n(b) In addition to the assignments permitted in clause (a) of this Section 10.12, each Bank and any assignee pursuant to clause (a) above shall have the right with the written consent of the Company to grant participations to one or more banks or other financial institutions in or to its Commitment, any Loan, any LC, the Related Documents, and the Note held by such Bank or such assignee, provided that (i) each Bank's obligations under this Agreement shall remain unchanged and (ii) the Company and the Agent shall continue to deal solely and exclusively with such Bank. No holder of a participation in all or any part of a Commitment, the Loans, the LCs, the Related Documents, or any Note shall have any rights under this Agreement; provided, however, that, to the extent permitted by applicable law, each holder of a participation shall have the same rights as each Bank under Section 5.3.\n(c) The Company hereby consents to the disclosure of any information obtained in connection herewith (i) by each Bank, to any bank or other financial institution which is an assignee or potential assignee with respect to which the Company has given its written consent pursuant to clause (a) above, and (ii) by each Bank and any assignee pursuant to clause (a) above, to any bank or other financial institution which is a participant or potential participant with respect to which the Company has given its written consent pursuant to clause (b) above, it being understood that each Bank and each assignee shall advise any such bank or other financial institution of its obligation to keep confidential any nonpublic information disclosed to it pursuant to this Section 10.12.\nSECTION 10.13 Confidentiality. Each Bank agrees to take normal and reasonable precautions and exercise due care to maintain the confidentiality of all information provided to it by the Company, or by the Agent on the Company's behalf, in connection with this Agreement or any other Related Document, and neither it nor any of its Affiliates shall use\nany such information for any purpose or in any manner other than pursuant to the terms contemplated by this Agreement, except to the extent such information (i) was or becomes generally available to the public other than as a result of a disclosure by such Bank, or (ii) was or becomes available on a non-confidential basis from a source other than the Company, provided that such source is not bound by a confidentiality agreement with the Company known to such Bank; provided, further, however, that any Bank may disclose such information (A) at the request or pursuant to any requirement of any governmental or regulatory authority to which such Bank is subject or in connection with an examination of such Bank by any such authority; (B) pursuant to subpoena or other court process, provided that, if it is lawful to do so, such Bank shall give prompt notice to the Company of service thereof so that the Company may seek a protective order or other appropriate remedy or waive compliance with the provisions of this Section 10.13; (C) when required to do so in accordance with the provisions of any applicable requirement of law; (D) to the extent reasonably required in connection with any litigation or proceeding to which the Agent, any Bank or their respective Affiliates may be party, (E) to the extent reasonably required in connection with the exercise of any remedy hereunder or under any other Related Document, and (F) to such Bank's independent auditors and other professional advisors.\nSECTION 10.14 Notification of Addresses, Etc. Each Bank shall notify the Agent in writing of any changes in the address to which notices to such Bank should be directed, of payment instructions in respect of all payments to be made to it hereunder and of such other administrative information as the Agent shall reasonably request.\nIN WITNESS WHEREOF, the Company, the Agent, and each Bank have caused this Agreement to be executed and delivered as of the day and year first above written.\nTHE COMPANY:\nPIONEER FINANCIAL SERVICES, INC.\nBy: /s/ Val Rajic Title: Vice President\n1750 Golf Road Schaumburg, Illinois 60101 Attention: David Vickers Val Rajic Telephone: (708) 995-0400 Telecopy: (708) 413-7195\nTHE AGENT:\nAMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO\nBy /s/ Arthur Murray Vice President\n33 North LaSalle Street Chicago, Illinois 60690 Attention: Arthur W. Murray Telephone: (312) 661-7298 Telecopy: (312) 661-6929\nTHE BANKS:\nCOMMITMENT: AMERICAN NATIONAL BANK AND TRUST $9,000,000 COMPANY OF CHICAGO\nBy /s/ Arthur Murray Vice President\n33 North LaSalle Street Chicago, Illinois 60690 Attention: Arthur W. Murray Telephone: (312) 661-7298 Telecopy: (312) 661-6929\n$6,000,000 FIRSTAR BANK MILWAUKEE, N.A.\nBy /s/ Stephen Check Title: Vice President\n777 East Wisconsin Avenue Milwaukee, Wisconsin 53202 Attention: Stephen E. Check Telephone: ________________________ Telecopy: _________________________\n$5,000,000 BANK ONE, ROCKFORD, NA\nBy /s/ Robert Opperman Title: Vice President\nEast State at Mulford Road Rockford, Illinois 61110-4900 Attention: Robert Opperman Telephone: ________________________ Telecopy: _________________________\nEXHIBIT 11\nPIONEER FINANCIAL SERVICES, INC.\nSTATEMENT OF COMPUTATION OF PER SHARE\nNET INCOME OR LOSS\nFor the Year Ended December 31 1993 1992 1991\nNet Income (loss) $ 12,145,000 $(16,959,000) $ 8,872,000 Less Dividends on Preferred Stock (2,021,000) (2,039,000) (2,039,000)\nPrimary Basis-Net Income (loss) $ 10,124,000 $(18,998,000) $ 6,833,000\nFully Diluted Basis- Net Income (loss)** $ 13,507,000 $(16,959,000) $ 8,872,000\nAverage shares outstanding 6,546,719 6,659,657 6,626,447 Common Stock equivalents from dilutive stock options, based on the treasury stock method using average market price 176,883 - 72,092\nTOTAL-PRIMARY BASIS 6,723,602 6,659,657 6,698,539\nAdditional shares assuming conversion of Preferred Stock 1,515,200 1,535,360 1,535,360 Additional shares assuming conversion of Subordinated Debentures 2,282,774 - - Additional Common Stock equivalents from dilutive stock options, based on the treasury stock method using closing market price 209,618 - -\nTOTAL-FULLY DILUTED 10,731,194 8,195,017 8,233,899\nNet income (loss) per share- Primary $ 1.51 $(2.85) $ 1.02\nNet income (loss) per share- Fully Diluted $ 1.26 $(2.85)* $ 1.02 *\n* In 1991 and 1992 fully diluted net income (loss) per share is equivalent to primary net income (loss) per share due to the fully diluted computation\nbeing anti-dilutive for these periods.\n** In 1993 fully diluted net income per share was calculated after adding tax effected interest on Subordinated Debentures of $1,362,000.\nExhibit 21 PIONEER FINANCIAL SERVICES, INC.\nSubsidiary Jurisdiction\n1. Pioneer Life Insurance Company of Illinois Illinois 2. Health and Life Insurance Company of America Illinois\n3. National Group Life Insurance Company Illinois 4. First Pioneer Equity Corporation Delaware\n5. Pioneer Fire & Casualty Insurance Company Pennsylvania 6. Administrators Service Corporation Illinois\n7. Association Management Corporation Illinois 8. Network Air Medical Systems, Inc. Illinois\n9. National Benefit Plans, Inc. formerly National Group Holding Corporation Delaware 10. Design Benefit Plans, Inc. formerly National Group Marketing Corporation Illinois\n11. Partners Health Group, Inc. formerly Union Capital Corporation Delaware 12. National Marketing Specialists Delaware\n13. National Business Concepts, formerly Design Benefit Plans, Inc. formerly National Marketing Corporation Illinois 14. Target Ad Group, Inc. formerly National Benefit Finance, formerly Select Marketing Corporation Illinois\n15. Response Air Ambulance Network, Inc. Illinois 16. National Training Corporation formerly NGM Training Corporation formerly Educational Communications, Inc. Texas\n17. Direct Financial Services, Inc. Illinois 18. Association Specialty Corporation Illinois\n19. National Health Services, Inc. Wisconsin 20. Manhattan National Life Insurance Company North Dakota\n21. United Group Holdings of Delaware, Inc. Delaware 22. Advantage Financial Systems, Inc. Delaware\n23. NHS Coordinated Care of Texas, Inc. formerly American Managed Care of Texas, Inc. Texas 24. NHS Coordinated Care, Inc. Nevada\n25. Continental Life & Accident Company Iowa 26. Continental Marketing Corporation Idaho\n27. Healthcare Review Corporation Kentucky\nEXHIBIT 23\nCONSENT OF ERNST & YOUNG, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements pertaining to the Nonqualified Stock Option Plan of Pioneer Financial Services, Inc. (Form S-8 No. 33-37305), the Pioneer Financial Services, Inc. Employee Savings and Stock Ownership Plan (Form S-8 No. 33-45894) and the National Benefit Plans, Inc. 1992 Agent Stock Purchase Plan (Form S-8 No. 33-53686) of our report dated March 2, 1994, with respect to the consolidated financial statements and schedules of Pioneer Financial Services, Inc. and subsidiaries included in the Annual Report (Form 10-K) for the year ended December 31, 1993.\nERNST & YOUNG\nChicago, Illinois March 28, 1994"},"word_count":{"kind":"number","value":57688,"string":"57,688"},"character_count":{"kind":"number","value":358318,"string":"358,318"}}},{"rowIdx":286,"cells":{"filename":{"kind":"string","value":"7332_1993.txt"},"id":{"kind":"string","value":"7332_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"7332"},"text":{"kind":"string","value":"ITEM 1. BUSINESS Southwestern Energy Company (the Company) is a diversified natural gas company which conducts its primary activities through four wholly owned subsidiaries. The Company operates principally in the exploration and production segment and the gas distribution segment of the natural gas industry. The Company was incorporated on July 2, 1929, under the laws of the State of Arkansas. The Company operates an integrated natural gas gathering, transmission and distribution system in northwest Arkansas, and natural gas distribution systems in northeast Arkansas and parts of Missouri. The nature of the Company's natural gas transmission and distribution operations changed in 1992 when a new 258 mile long intrastate pipeline in which the Company owns an interest commenced operations. The intrastate pipeline crosses three interstate pipelines and ties the Company's distribution and gathering pipeline systems in northwest Arkansas to its distribution systems in northeast Arkansas and southeast Missouri. The Company also serves as operator of the pipeline. In 1943, the Company commenced a program of exploration for and development of natural gas reserves in Arkansas for supply to its utility customers. In 1971, the Company initiated an exploration and development program outside Arkansas, unrelated to the utility requirements. Since that time, the Company's exploration and development activities outside Arkansas have expanded. The exploration, development and production activities are a separate, primary business of the Company. The Company is an exempt holding company under the Public Utility Holding Company Act of 1935. Exploration and production activities consist of ownership of mineral interests in productive and undeveloped leases located entirely within the United States. The Company engages in gas and oil exploration and production through its subsidiaries, SEECO, Inc. (SEECO) and Southwestern Energy Production Company (SEPCO). SEECO operates exclusively in the State of Arkansas and holds a large base of both developed and undeveloped gas reserves and conducts an ongoing drilling program in the historically productive Arkansas section of the Arkoma Basin. SEPCO conducts an exploration program in areas outside Arkansas, primarily the Gulf Coast areas of Texas and Louisiana. SEPCO also holds a block of leasehold acreage located on the Fort Chaffee military reservation in western Arkansas and in other parts of Arkansas away from the operating areas of the Company's other subsidiaries. The Company's subsidiary Arkansas Western Gas Company (Arkansas Western) operates integrated natural gas distribution systems in Arkansas and Missouri. Arkansas Western is the largest single purchaser of SEECO's gas production. Southwestern Energy Pipeline Company (SWPL) owns an interest in the NOARK Pipeline System (NOARK), an intrastate natural gas transmission system which extends across northern Arkansas. A discussion of the primary businesses conducted by the Company through its wholly owned subsidiaries follows. NATURAL GAS AND OIL EXPLORATION AND PRODUCTION Substantially all of the Company's exploration and production activities and reserves are concentrated in the Arkoma Basin of Arkansas and the Gulf Coast areas of Texas and Louisiana. At December 31, 1993, the Company had proved natural gas reserves of 318.8 billion cubic feet (Bcf) and proved oil reserves of 479 thousand barrels (MBbls). Revenues of the exploration and production subsidiaries are predominately generated from production of natural gas. The Company's gas production increased for the sixth consecutive year in 1993, totaling 35.4 Bcf, up 39% from 25.5 Bcf in 1992. Sales of gas production accounted for 97% of total operating revenues for this segment in 1993, 95% in 1992 and 91% in 1991. SEECO's largest customer for sales of its gas production was the Company's utility subsidiary. Sales to unaffiliated purchasers by both SEECO and SEPCO have increased significantly, however, during the last few years primarily as a result of higher production from\nArkansas properties and from discoveries made in earlier years offshore in the Gulf of Mexico. Sales to unaffiliated purchasers accounted for 64% of total gas volumes sold by the exploration and production segment in 1993, 55% in 1992 and 35% in 1991. Gas volumes sold by SEECO to Arkansas Western for its northwest Arkansas division (AWG) were approximately 7.1 Bcf in 1993, 7.2 Bcf in 1992 and 7.6 Bcf in 1991. Through these sales, SEECO furnished approximately 50% of the northwest Arkansas system's requirements in each of these years. SEECO also delivered approximately 2.2 Bcf in 1993, 2.8 Bcf in 1992 and .6 Bcf in 1991 directly to certain large business customers of AWG through a transportation service of the utility subsidiary that became effective in October, 1991. These customers previously purchased the majority of their requirements directly from AWG through a spot market purchasing program offered by the utility. Most of the sales to AWG are pursuant to a twenty-year contract between SEECO and AWG which committed to the utility all Company owned reserves in Arkansas as of the contract date of July 24, 1978. Most reserves committed to this contract were classified as Section 105 gas under the Natural Gas Policy Act of 1978 (NGPA). Section 105 covers gas committed to intrastate commerce at the date of enactment of the NGPA and provides that the price received for any such gas will be the contract price, provided that the contract price does not exceed the maximum price as published quarterly by the Federal Energy Regulatory Commission (FERC) for Section 102 gas under the NGPA. The pricing under this contract has been frozen at the December, 1984 level. All gas dedicated to this contract was deregulated as of January 1, 1993. Reserves discovered after the contract date in areas not previously committed to the utility may be sold to the utility at prices determined by present gas market conditions or to unaffiliated companies. The contract also contains provisions for the release of dedicated reserves for sale to unaffiliated companies in certain circumstances. In addition to this contract, SEECO also sells gas to AWG under newer long-term contracts with flexible pricing provisions and under short-term spot market arrangements. SEECO's sales to AWG accounted for approximately 31%, 45% and 49% of total exploration and production revenues in 1993, 1992 and 1991, respectively. In November, 1993, the Arkansas Public Service Commission (APSC or Commission) issued an order which found the purchases of AWG under the 1978 contract to be in violation of an Arkansas statute requiring that gas purchases be made \"from the lowest or most advantageous market.\" The APSC order is discussed more fully below under \"Natural gas gathering, transmission and distribution.\" SEECO's sales to Associated Natural Gas Company (Associated), a division of Arkansas Western which operates natural gas distribution systems in northeast Arkansas and parts of Missouri, were 5.7 Bcf in 1993, 4.3 Bcf in 1992 and 5.3 Bcf in 1991. These deliveries accounted for approximately 67% of Associated's total requirements in 1993, 56% in 1992 and 55% in 1991. These sales represented 15% of total exploration and production revenues in 1993, 14% in 1992 and 20% in 1991. Deliveries to Associated increased in 1993 primarily due to colder winter heating weather and storage requirements during the summer months. The decrease in volumes delivered to Associated in 1992, as compared to 1991, was primarily the result of some of Associated's larger industrial customers switching to transportation service. Effective October, 1990, SEECO entered into a ten-year contract with Associated to supply its base load system requirements at a price to be redetermined annually. Deliveries under this contract were made at a price of $1.90 per thousand cubic feet (Mcf) from inception of the contract through the first nine months of 1993, and are currently being made at a price of $2.385 per Mcf. In 1990, SEECO completed the initial mapping and engineering phases of a multi-year geological field study of the Arkoma Basin of Arkansas. The product developed was an extensive database and geologic interpretations of the distribution of gas-bearing sands in the region and resulted in the identification of 69.7 Bcf of proved undeveloped reserves that were added to the Company's base of proved reserves. At December 31, 1993, after\ntransfers and revisions, the remaining proved undeveloped reserves identified by the study were 55.8 Bcf. The data base developed is continually updated by drilling activity and serves as the guide for a development drilling program that the Company plans to continue over the next several years. The development drilling program added 27.0 Bcf in 1993 and 22.5 Bcf in 1992 of new natural gas reserve additions and resulted in the transfer of 2.6 Bcf in 1993 and 8.7 Bcf in 1992 from the proved undeveloped category to the proved developed category. SEECO participated in a total of 74 development wells during 1993 with a completion rate of 73% and expects the number of wells drilled in 1994 to approximate the number drilled in 1993. SEECO's sales to unaffiliated purchasers increased to 9.7 Bcf in 1993, from 4.5 Bcf in 1992 and 1.1 Bcf in 1991. The increase in both years resulted from the Company's development drilling program. At present, SEECO's contracts for sales of gas to unaffiliated customers consist of short-term sales made to customers of AWG's transportation program, which became effective in October, 1991, and spot sales into markets away from AWG's distribution system. In the past, the Company's ability to enter into sales arrangements with unaffiliated customers has generally been constrained by a lack of pipeline transportation to markets away from the Arkoma Basin. Initiatives of the FERC to restructure the natural gas interstate pipeline service rules through its Order No. 636 series have improved and should continue to improve the Company's ability to market its existing and potential reserves. Also contributing to the increase in the ability of SEECO to market its gas to unaffiliated customers was the completion in September, 1992 of NOARK, as explained more fully below under \"Natural gas gathering, transmission and distribution.\" At December 31, 1993, the gas reserves of SEPCO were located primarily in the states of Arkansas, Oklahoma, Louisiana and offshore Texas, while its oil reserves were located primarily in Oklahoma, North Dakota, Louisiana and offshore Texas. SEPCO holds about 22% of the Company's natural gas reserves and all of its oil reserves. SEPCO's gas sales increased to 12.9 Bcf in 1993, from 9.6 Bcf in 1992 and 5.9 Bcf in 1991. The increase in 1993 was primarily the result of increased production from properties located in the Gulf of Mexico. The increase in 1992 was the result of sales from Fort Chaffee, as discussed below. The Company's production from Fort Chaffee and the Gulf of Mexico is sold under contracts which reflect current short-term prices and which are subject to seasonal price swings. The Company curtailed gas production during 1992 and 1991 when sales prices were deemed below acceptable levels. Oil production was 96 MBbls in 1993, compared to 120 MBbls in 1992, and 176 MBbls in 1991. The Company's exploration program has been directed almost exclusively toward natural gas in recent years. The Company plans to continue to concentrate on developing gas reserves for production but will also selectively seek opportunities to participate in projects oriented toward oil production. Over the long-term, however, oil sales are not expected to account for a significant part of the Company's future revenues. SEPCO's gas and oil sales accounted for approximately 33% of total gas and oil operating revenues in 1993, 31% in 1992, and 26% in 1991. In 1989, SEPCO purchased at oral auction 11,000 undrilled acres containing 17 separate drilling units on the Fort Chaffee military reservation of western Arkansas. The total cost of this acreage was approximately $11.0 million. Conflicts with military training activities have limited SEPCO's drilling operations at Fort Chaffee. The primary training function at Fort Chaffee was transfered to another military installation during 1993 and it appears that scheduling conflicts should be lessened in the future. To date the Company has drilled or participated in eight wells at Fort Chaffee that have discovered an estimated 46.6 Bcf of new gas reserves, net to the Company's interest. SEPCO is currently completing evaluation of a seven line seismic program on its Fort Chaffee acreage. The data provided by the seismic program will be used to develop an exploration plan covering the remainder of SEPCO's acreage at Fort Chaffee. The plan will then be submitted for military approval with a goal of conducting further exploration drilling during 1994. Sales of gas production from Fort Chaffee began\nin August, 1991 and totaled 5.1 Bcf in 1993, 5.8 Bcf in 1992 and 2.2 Bcf in 1991. Since late 1992, sales from Fort Chaffee have taken place under a firm sales contract for 25 million cubic feet per day (MMcfd) to an independent marketer. The gas was transported by the marketer under a firm transportation contract on NOARK. The Company met its obligation under the firm sales contract in part by providing gas supplied from SEECO's development drilling program. In late 1993, the marketer filed suit against NOARK, the Company and certain of its affiliates, seeking rescission of the firm sales and transportation contracts. Since that time, the Company has entered into its own sales arrangements covering the affected gas production and does not believe its sales will be adversely affected while the litigation is proceeding. This gas production continues to be transported through NOARK at a price based on current spot market prices, net of transportation. See discussion at \"Natural gas gathering, transmission and distribution\" for additional information concerning the independent marketer's decision to cease honoring its contractual obligations. Outside Arkansas, the Company added 19.0 Bcf of new reserves from drilling, with 15.2 Bcf of that from an onshore discovery in the coastal area of southeast Louisiana. The Gulf Coast region continues to be the focus of most of the Company's exploration activity outside Arkansas. The Company expects in the future to direct its exploration activities toward the onshore Gulf Coast by focusing on the internal generation of prospects in the upper Texas Gulf Coast and in south Louisiana. SEPCO is also participating with an interest of approximately 50% in an exploration program on a 135,000 acre farmout by a major oil company of acreage held by production in the Oklahoma Panhandle. Though the wells drilled are of smaller magnitude than SEPCO's typical Gulf Coast prospect, drilling costs in the Oklahoma Panhandle are low and the wells are economically attractive. Six tests drilled to date have resulted in five completions. Approximately seven new test wells are planned for 1994. In the natural gas and oil exploration segment, competition is encountered primarily in obtaining leaseholds for future exploration. Competition in the State of Arkansas has increased in recent years, due largely to the development of improved access to interstate pipelines. Due to the Company's significant holdings of undeveloped acreage in Arkansas and its long-time presence and reputation in this area, the Company believes it will continue to be successful in acquiring new leases in Arkansas. While improved intrastate and interstate pipeline transportation in Arkansas should increase the Company's access to markets for its gas production, these markets will generally be served by a number of other suppliers. Thus, the Company will encounter competition which may affect both the price it receives and contract terms it must offer. Outside Arkansas, the Company is less well-established and faces competition from a larger number of other producers. The Company has in recent years been successful in building its inventory of undeveloped leases and obtaining participating interests in drilling prospects outside Arkansas. The Company expects its 1994 capital expenditures for gas and oil exploration and development to total $50.0 million, up from $37.4 million in 1993. Most of the increase in capital spending will be directed to the onshore Gulf Coast along with Fort Chaffee and the Oklahoma Panhandle. The Company will review this budget periodically during the year for possible adjustment depending upon cash flow projections related to fluctuating prices for oil and natural gas. NATURAL GAS GATHERING, TRANSMISSION AND DISTRIBUTION The Company's natural gas distribution operations are concentrated primarily in north Arkansas and southeast Missouri. The Company serves approximately 160,000 retail customers and obtains a substantial portion of the gas they consume through its Arkoma Basin gathering facilities. The Company is also a participant in a partnership that owns the NOARK Pipeline System. The complexity of AWG's distribution operations, particularly its gathering system in the Arkoma Basin gas fields, increased significantly with the start up of\nNOARK. AWG provides field management services to NOARK under a contract with the partnership and AWG's gathering system delivers to NOARK a substantial part of the gas NOARK transports. The Company completed a pipeline in 1993 that connects NOARK to Associated's distribution system, tying together the Company's two primary gas distribution systems. Arkansas Western consists of two operating divisions. The AWG division gathers natural gas in the Arkansas River Valley of western Arkansas and transports the gas through its own transmission and distribution systems, ultimately delivering it at retail to approximately 93,000 customers in northwest Arkansas. The Associated division currently receives its gas from transportation pipelines and delivers the gas through its own transmission and distribution systems, ultimately delivering it at retail to approximately 67,000 customers primarily in northeast Arkansas and southeast Missouri. Associated, formerly a wholly owned subsidiary of Arkansas Power and Light Company, was acquired and merged into Arkansas Western, effective June 1, 1988. The Arkansas Public Service Commission (APSC) and the Missouri Public Service Commission (MPSC) regulate the Company's utility rates and operations. In Arkansas, the Company operates through municipal franchises which are perpetual by state law. These franchises, however, are not exclusive within a geographic area. In Missouri, the Company operates through municipal franchises with various terms of existence. AWG and Associated deliver natural gas to residential, commercial and industrial customers. The industrial customers are generally smaller concerns using gas for plant heating or product processing. AWG has no restriction on adding new residential or commercial customers and will supply new industrial customers which are compatible with the scale of its facilities. AWG has never denied service to new customers within its service area or experienced curtailments because of supply constraints. Associated has not denied service to new customers within its service area or experienced curtailments because of supply constraints since the acquisition date, although service restrictions and supply related curtailments did occur prior to that time. Curtailment of large industrial customers of AWG and Associated occurs only infrequently when extremely cold weather requires their systems to be dedicated exclusively to human needs customers. AWG and Associated have experienced a general trend in recent years toward lower rates of usage among their customers, largely as a result of conservation efforts which the Company encourages. Competition is increasingly being experienced from alternative fuels, primarily electricity, fuel oil and propane. A significant amount of fuel switching has not been experienced, though, as natural gas is generally the least expensive, most readily available fuel in the service territories of AWG and Associated. The Company is, however, beginning to experience competition from alternative suppliers of natural gas. The competition from alternative fuels and alternative sources of natural gas has intensified in recent years as a result of the significant declines in prices of petroleum products and the deliverability surplus of natural gas experienced in the recent past. Industrial customers are most likely to consider utilization of these alternatives, as they are less readily available to commercial and residential customers. In an effort to provide some pricing alternatives to its large industrial customers with relatively stable loads, AWG offers an optional tariff to its larger business customers and to any other large business customer which shows that it has an alternate source of fuel at a lower price or that one of its direct competitors in another area has access to cheaper sources of energy. This optional tariff enables those customers willing to accept the risk of price and supply volatility to direct AWG to obtain a certain percentage of their gas requirements in the spot market. Participating customers continue to pay the nongas costs of service included in AWG's present tariff for large business customers and agree to reimburse AWG for any take-or-pay liability caused by spot market purchases on the customer's behalf. In an effort to more fully meet the service needs of larger business customers, both AWG and Associated instituted a transportation service in October, 1991, that allows such customers in Arkansas to obtain their own\ngas supplies directly from other suppliers. Associated has offered transportation service to its larger customers in Missouri for several years and AWG's spot market purchasing program has provided customers in northwest Arkansas with many of the benefits of transportation service. Under the programs, transportation service is available in Arkansas to any large business customer which consumes a minimum of 150,000 Mcf per year and no less than 3,000 Mcf per month. Transportation service is available in Missouri to any customer whose average monthly useage exceeds 2,000 Mcf. The minimums can be met by aggregating facilities under common ownership. A total of eleven customers are currently using the Arkansas transportation service, including AWG's three largest customers in northwest Arkansas and Associated's largest customer in northeast Arkansas. In its order approving the transportation program, the APSC indicated that it would review the program after one year and consider the desirability of lowering the minimum volume requirement. The APSC also indicated that it would consider in 1992 whether AWG's spot market purchasing program should be continued. The APSC has deferred the review of both programs to a later date. AWG purchases its system gas supply directly at the wellhead under long-term contracts. Purchases are made from approximately 310 working interest owners in 475 producing wells. Most of the volumes purchased by AWG are covered by contracts which contain provisions for periodic or automatic escalation in the price to be paid. In the mid-1980's, however, AWG took steps to freeze the prices paid under those contracts containing indefinite price escalators tied to Section 102 or prices escalating under Section 103 of the NGPA. Producers under these contracts were offered an amendment freezing the price at the December, 1984 level, with a right to renegotiate in one year. AWG received acceptances from producers holding the majority of the reserves under such contracts, either accepting the amendment or agreeing to freeze the price. Since that time, the price freeze has remained in effect and AWG has continued to make payments at the frozen 1984 price levels. This price freeze applies to gas purchased from SEECO, as well as to purchases from unaffiliated producers. A significant portion of AWG's supply comes from newer, market responsive, long-term contracts which take advantage of the lower prices presently available from gas suppliers. At December 31, 1993, AWG had a gas supply available to its northwest Arkansas system of approximately 237 Bcf of proved developed reserves, equal to 17 times current annual usage. Of this total, approximately 116 Bcf were net reserves available from SEECO. For purposes of determining AWG's available gas supply, deliveries to AWG's spot market purchasing program or transportation customers and the reserves related to those deliveries are not considered. Prior to 1993, Associated purchased gas for its system supply from six interstate pipelines, SEECO and various spot market suppliers. As a result of the unbundling of gas sales, gathering, transmission and storage services by interstate pipelines mandated by the FERC's Order No. 636, (discussed more fully below), Associated now purchases gas for its system supply from unaffiliated suppliers in the producing fields accessed by interstate pipelines and from SEECO. As previously discussed, Associated purchases its base load system requirements from SEECO under a ten-year contract with annual price redeterminations. Purchases made from unaffiliated suppliers are under purchase contracts with expiration dates ranging from October, 1994 to December, 1995. The rates charged by these suppliers include demand components to ensure availability of gas supply, administration fees and a commodity component which is based on spot market gas prices. Associated's gas purchases are transported through nine pipelines. The pipeline transportation rates include demand charges to reserve pipeline capacity and commodity charges based on volumes transported. Associated has also contracted with five of the interstate pipelines for storage capacity to meet its peak seasonal demands. These contracts involve demand charges based on the maximum deliverability, capacity charges based on the maximum storage quantity, and charges for the quantities injected and withdrawn.\nOver the past several years changes at the federal level have brought significant changes to the regulatory structure governing interstate sales and transportation of natural gas. The FERC's Order No. 636 series changed a major portion of the gas acquisition merchant function provided to gas distributors by interstate pipelines. AWG already obtains its supply at the wellhead directly from producers and will not be directly impacted by Order No. 636. Associated has acquired the bulk of its gas supply at the wellhead since its acquisition by AWG, but continues to purchase a portion of both its peak and base requirements from interstate suppliers. During 1993, Associated renegotiated those contracts in accordance with the pipeline restructurings before the FERC. The changes mandated by Order No. 636 have placed the responsibility for arranging firm supplies of natural gas directly on local distribution companies and have, as a result, lessened the ability of Associated to purchase gas on the short-term spot market. Some of AWG's long-term purchase contracts with unaffiliated companies provide for payments to be made if AWG does not take an annual, minimum quantity of gas (take-or-pay). Any payments made are recovered if the gas is taken before a certain date in the future. As of December 31, 1993, AWG had no unrecovered payments of this type. Associated's previous gas purchase contracts with interstate pipelines also contained take-or-pay provisions. To date, Associated has paid approximately $3.2 million for contract reformation costs incurred by its interstate pipeline suppliers and for contracted quantities of gas not taken. The Company believes these costs are recoverable from its utility customers and expects approval from the proper regulatory agencies after the payments are reviewed in the normal course of business. To date Associated has recovered, subject to refund, approximately $1.6 million of these charges from its customers. The implementation in 1991 of transportation service in Arkansas increases the exposure of AWG and Associated to take-or-pay liabilities, but the Company expects to continue to be able to satisfactorily manage this exposure. AWG has negotiated certain modifications to some of its gas purchase contracts which contain market-out provisions to decrease its exposure to take-or-pay liabilities. The gas heating load is one of the most significant uses of natural gas and is sensitive to outside temperatures. Sales, therefore, vary throughout the year. Profits, however, have become less sensitive to fluctuations in temperature in recent years as the structure of the Company's utility rates has become somewhat flatter; i.e., most recovery of return on rate base is built into a customer charge and the first step of its rates. AWG and Associated pass along to customers through an automatic cost of gas adjustment clause any increase or decrease experienced in purchased gas costs. As previously mentioned, the APSC and the MPSC regulate the Company's utility rates and operations. Late in 1990, the APSC and the MPSC approved rate increases for the Company totaling $7.4 million annually. AWG received an increase of $5.7 million annually and Associated was awarded an increase of $.9 million annually for its Missouri properties and $.8 million annually for its system in Arkansas. Arkansas Western has no immediate plans to file for additional rate increases as customer growth and transportation revenues have helped to offset the effects of attrition since the last rate case. AWG's rates for gas delivered to its customers are not regulated by the FERC, but its transmission and gathering pipeline systems are subject to the FERC's regulations concerning open access transportation since AWG accepted a blanket transportation certificate in connection with its merger with Associated. In its order approving the 1990 Arkansas rate increase, the APSC established procedures to investigate a number of changes in the regulatory mechanisms under which purchased gas costs are charged to and recovered from the customers of the utility subsidiary. The APSC indicated that its interest was heightened by the fact that Arkansas Western purchases a substantial portion of the gas supply for both AWG and Associated from SEECO. Most of the sales of SEECO's production to AWG take place under a twenty- year, fixed price contract which was approved by the APSC in connection with a corporate rearrangement of the Company in 1978 (the 1978\ncontract). Additionally, the APSC Staff has regularly examined and accepted the gas purchase costs of the utility subsidiary since the Commission approved the corporate reorganization in 1978. These examinations included a review in the 1990 rate case by an outside consultant hired directly by the APSC Staff. That consultant performed an extensive review of the utility's purchasing practices and gas costs, including its purchases from the Company's exploration and production segment, and recommended in filed testimony sponsored by the APSC Staff that all of the utility's gas costs including purchases under the contract in question, be accepted without adjustment. The APSC originally ordered that its proposals related to gas cost recovery and pricing be considered by the parties to the proceeding with the goal of reaching a mutually agreeable resolution of its concerns. After meeting extensively, the parties were unable to reach such a resolution and each party to the proceeding filed its own report with the APSC in July, 1991. In February, 1992, the APSC issued an order establishing a procedural schedule to further address the issues raised by its Staff and Office of the Attorney General of the State of Arkansas (AG). In establishing the schedule, the APSC stated that the record developed does not contain adequately developed evidence on which an informed decision on those issues can be based. The APSC also stated that it will consider only those proposals proffered by the parties which address prospective gas cost reductions. The APSC conducted a hearing in January, 1993, concerning the issues raised in its 1990 order. In November, 1993, the APSC issued an order that found AWG's purchases under the contract in question to be in violation of an Arkansas statute requiring that gas purchases be made \"from the lowest or most advantageous market\" and that the price paid by AWG was too high. In that same order, the APSC found that purchases by Associated were in compliance with the statute. The order also scheduled a hearing for mid- January, 1994 to accept additional evidence as to the price which should be paid under the AWG contract. At the January, 1994 hearing, both the Staff of the APSC and the AG presented testimony describing recommendations designed to lower the price received by the Company's exploration and production subsidiary under the contract. The Company presented testimony which it believes reinforced its position that the contractual arrangements questioned by the Commission are the most advantageous to its utility customers. Legal briefs were filed in late February, 1994, and the Company expects a Commission order to be forthcoming. If necessary, the Company intends to continue to defend its gas purchasing practices through the courts. The Company does not expect any outcome of this proceeding to have a material adverse impact on the financial position of the Company. Of the Company's 35.4 Bcf of gas production in 1993, approximately 6.0 Bcf was sold under the contract in question. As mentioned above, NOARK is an intrastate pipeline constructed by a limited partnership in which SWPL holds a 47.33% general partnership interest and is the pipeline's operator. NOARK's main line was completed and placed in service in September, 1992. A lateral line of NOARK that allows the Company's gas distribution segment to augment its supply to an existing market as well as supply gas to new markets was completed and placed in service in November, 1992. The 258 mile long pipeline originates near the Fort Chaffee military reservation in western Arkansas and terminates in northeast Arkansas. NOARK interconnects with three major interstate pipelines and provides additional access to markets for gas production of both the Company and other producers. Construction of an eight-mile interstate pipeline connecting NOARK to the distribution system of Associated was completed during 1993. NOARK has a capacity of 141 MMcfd and cost approximately $103.0 million to construct. NOARK's original cost estimate was approximately $73.0 million. The cost overrun was the result of the addition of a major central compressor station and increased costs incurred as a result of the rocky, mountainous terrain through which NOARK passes. NOARK completed its first full year of operation in 1993 and had an average daily throughput during the year of 79 MMcfd. Arkansas Western has contracted for 41 MMcfd of firm capacity on NOARK under a ten-year transportation contract. NOARK also has a five-year transportation contract with an independent marketer to transport 50 MMcfd through NOARK on a firm\nbasis. The Company's exploration and production segment supplies 25 MMcfd of the volumes transported by the marketer under that agreement. In late 1993, the gas marketing company filed suit against NOARK, the Company and certain of its affiliates, and, effective January 1, 1994, ceased transporting gas under its agreement with NOARK. The complaint seeks rescission of the transportation contract and a contract to purchase gas from the Company's affiliates, and actual and punitive damages. The Company and NOARK both believe the suit is without merit and have filed counterclaims seeking enforcement of the contracts and damages. The Company is currently making its own sales arrangements and transporting through NOARK the 25 MMcfd of production which was previously purchased by the marketer. NOARK provides additional pipeline capacity to a portion of the Arkoma Basin in Arkansas which was not previously adequately served by pipelines offering firm transportation. NOARK is currently incurring losses and the Company expects further losses from its equity investment in NOARK until the pipeline is able to increase its level of throughput and until improvement occurs in the competitive conditions which determine the transportation rates NOARK can charge. NOARK competes primarily with two interstate pipelines in its gathering area. One of those elected to become an open access transporter subsequent to NOARK's start of construction. That pipeline does not offer firm transportation, but the increased availability of interruptible transportation services intensified the competitive environment within which NOARK operates. The Company believes that the FERC's Order No. 636 restructuring rules implemented in the latter part of 1993 will have a positive impact on NOARK. The unbundling of gas sales, gathering, transmission and storage services required by Order No. 636 should provide NOARK with expanded options for accessing gas supply and for transporting gas to downstream customers. NOARK is a public utility regulated by the APSC. The APSC established NOARK's maximum transportation rate based on its original construction cost estimate of approximately $73.0 million. The Company is subject to laws and regulations relating to the protection of the environment. The Company's policy is to accrue environmental and cleanup related costs of a non-capital nature when it is both probable that a liability has been incurred and when the amount can be reasonably estimated. The Company has no material amounts accrued at December 31, 1993. Additionally, management believes any future remediation or other compliance related costs will not have any material effect upon capital expenditures, earnings or the competitive position of the Company's subsidiaries in the segments in which they operate. REAL ESTATE DEVELOPMENT A. W. Realty Company (AWR) owns approximately 170 acres of real estate, most of which is undeveloped. AWR's real estate development activities are concentrated on a 130-acre tract of land located near the Company's headquarters in a growing part of Fayetteville, Arkansas. The Company has owned an interest in this land for many years. The property is zoned for commercial, office and multi-family residential development. AWR continues to review with a joint venture partner various options for developing this property which would minimize the Company's initial capital expenditures but still enable it to retain an interest in any appreciation in value. This activity, however, does not represent a significant portion of the Company's business. EMPLOYEES At December 31, 1993, the Company had 651 employees, 85 of whom are represented under a collective bargaining agreement. INDUSTRY SEGMENT AND STATISTICAL INFORMATION The following portions of the 1993 Annual Report to Shareholders (filed as Exhibit 13 to this filing) are hereby incorporated by reference for the purpose of providing additional information about its business. Refer to Note 9 to the financial statements for information about industry segments and \"Financial and Operating\nStatistics\" for additional statistical information, including the average sales price per unit of gas produced and of oil produced and the average production cost per unit. ITEM 2.\n\n\nITEM 2. PROPERTIES The portions of the 1993 Annual Report to Shareholders (filed as Exhibit 13 to this filing) listed below are hereby incorporated by reference for the purpose of describing its properties. Refer to the Appendix for information concerning areas of operation of the Company's gas distribution systems. For information concerning the Company's exploration and production areas of operation, also refer to the Appendix. See the table entitled \"Operating Properties\" at the Appendix for information concerning miles of pipe of the Company's gas distribution systems and for information regarding leasehold acreage and producing wells by geographic region of the Company's exploration and production segment. Also, see Notes 5 and 6 to the financial statements for additional information about the Company's gas and oil operations. For information concerning capital expenditures, refer to the \"Capital Expenditures\" section of \"Management's Discussion and Analysis of Financial Condition and Results of Operations\". Also refer to \"Financial and Operating Statistics\" for information concerning gas and oil wells drilled and gas and oil produced. The following information is provided to supplement that presented in the 1993 Annual Report to Shareholders: NET WELLS DRILLED DURING THE YEAR\nWELLS IN PROGRESS AS OF DECEMBER 31, 1993\nDue to the insignificance of the Company's oil reserves and producing oil wells to its total reserves and producing wells, separate disclosure of gas and oil producing wells has not been made. No individually significant discovery or other major favorable or adverse event has occurred since December 31, 1993. During 1993, SEECO and SEPCO were required to file Form 23, \"Annual Survey of Domestic Oil and Gas Reserves\" with the Department of Energy. The basis for reporting reserves on Form 23 is not comparable to the reserve data included in Note 6 to the financial statements in the 1993 Annual Report to Shareholders. The primary differences are that Form 23 reports gross reserves, including the royalty owners' share and includes reserves for only those properties where either SEECO or SEPCO is the operator. ITEM 3.\nITEM 3. LEGAL PROCEEDINGS The Company and its subsidiaries are not involved and were not involved at December 31, 1993, in any material pending legal proceedings. The outcome of litigation in which the Company is involved would not have a material effect on the consolidated financial statements. ITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the fiscal year ended December 31, 1993, to a vote of security holders, through the solicitation of proxies or otherwise. EXECUTIVE OFFICERS OF THE REGISTRANT The following is information with regard to executive officers of the Company:\nAll officers are elected at the Annual Meeting of the Board of Directors for one-year terms or until their successors are duly elected. There are no arrangements between any officer and any other person pursuant to which he was selected as an officer. There is no family relationship between any of the executive officers.\nPART II ITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The \"Shareholder Information\" and \"Financial and Operating Statistics\" sections of the 1993 Annual Report to Shareholders (filed as Exhibit 13 to this filing) are hereby incorporated by reference for information concerning the market for and prices of the Company's common stock, the number of shareholders and cash dividends paid. The terms of the Company's long-term debt instruments and agreements impose restrictions on the payment of cash dividends. At December 31, 1993, $102,793,000 of retained earnings was available for payment as cash dividends. These covenants generally limit the payment of dividends in a fiscal year to the total of net income earned since January 1, 1990, plus $20,000,000 less dividends paid and purchases, redemptions or retirements of capital stock during the period since December 4, 1991. The Board of Directors increased the quarterly dividend by 20% in the third quarter of 1993, to $.06 per share, equal to an annual rate of $.24 per share (after the effect of a three-for-one stock split distributed August 5, 1993). While the Board of Directors intends to continue the practice of paying dividends quarterly, amounts and dates of such dividends as may be declared will necessarily be dependent upon the Company's future earnings and capital requirements. ITEM 6.\nITEM 6. SELECTED FINANCIAL DATA, AND ITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, AND ITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following portions of the 1993 Annual Report to Shareholders (filed as Exhibit 13 to this filing) are hereby incorporated by reference.\n\"Financial and Operating Statistics\" for selected financial data of the Company. The comparability of data between years is affected by the acquisition of Associated Natural Gas Company in June, 1988. \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The consolidated financial statements as detailed in item 14 (a)(1) below. ITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in or disagreements with accountants on accounting and financial disclosure. PART III ITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The definitive proxy statement to holders of the Company's common stock in connection with the solicitation of proxies to be used in voting at the Annual Meeting of Shareholders on May 25, 1994 (the 1994 Proxy Statement), is hereby incorporated by reference for the purpose of providing information about the identification of directors. Refer to the sections \"Election of Directors\" and \"Security Ownership of Nominees and Executive Officers\" for information concerning the directors. Information concerning executive officers is presented in Part I, Item 4 of this Form 10-K. ITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nThe 1994 Proxy Statement is hereby incorporated by reference for the purpose of providing information about executive compensation. Refer to the section \"Executive Compensation.\"\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe 1994 Proxy Statement is hereby incorporated by reference for the purpose of providing information about security ownership of certain beneficial owners and management. Refer to the section \"Security Ownership of Nominees and Executive Officers\" of the proxy statement for information about security ownership of certain beneficial owners and management.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe 1994 Proxy Statement is hereby incorporated by reference for the purpose of providing information about related transactions. Refer to the section \"Security Ownership of Nominees and Executive Officers\" and \"Compensation Committee Interlocks and Insider Participation\" for information about transactions with members of the Company's Board of Directors.\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) The following consolidated financial statements of the Company and its subsidiaries, included with its 1993 Annual Report to Shareholders (filed as Exhibit 13 to this filing) and the report of independent auditors on such report are hereby incorporated by reference:\nReport of Independent Auditors.\nConsolidated Balance Sheets as of December 31, 1993 and 1992.\nConsolidated Statements of Income for the years ended December 31, 1993, 1992 and 1991.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991.\nConsolidated Statements of Retained Earnings for the years ended December 31, 1993, 1992 and 1991.\nNotes to Consolidated Financial Statements, December 31, 1993, 1992 and 1991.\n(2) The following financial statement schedules for the years 1993, 1992 and 1991 are submitted herewith:\nAll other schedules are omitted because they are not required, inapplicable, or the information is otherwise shown in the financial statements or notes thereto.\n(3) The exhibits listed on the accompanying Exhibit Index (pages 23 - 25) immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this Report.\n(b) Reports on Form 8-K: No reports on Form 8-K were filed during the quarter ended December 31, 1993. The Company filed on January 17, 1994, a Current Report on Form 8-K reporting that the Arkansas Public Service Commission issued an order on November 29, 1993, in a three-year-old gas cost case involving purchases by Arkansas Western under a long-term gas purchase contract with SEECO. The order found Arkansas Western's purchases under the contract in question to be in violation of an Arkansas statute requiring that gas purchases be made \"from the lowest or most advantageous market.\" The order found that the price paid by Arkansas Western to its affiliate was too high, determined that purchases under the contract should be indexed to an \"appropriate market price\", but stated that \"additional evidence is necessary in order to determine the most equitable pricing methodology\" and \"the parties should provide testimony on any premium that should be attached to the published price to reflect Arkansas Western's gas requirements.\" The Commission scheduled a public hearing on these issues to begin on January 18, 1994. Additionally, as reported on the Form 8-K, a class action refund complaint was filed against Arkansas Western in December, 1993, asking the APSC to order Arkansas Western to refund amounts related to gas costs collected from its customers since 1978. The claim purports to be a class action, although no Arkansas law specifically authorizes the pursuit of class action complaints before the APSC. The complaint is based on the APSC's order discussed above. The complaint requests that the Commission order Arkansas Western to refund its ratepayers and customers at least $14 million per year since 1978 or $210 million or the amount by which the rates charged have exceeded the amount reasonably justified by the rules of the APSC and the statutes of Arkansas. The complaint does not explain how the refund amount was calculated, and no refund amount can be calculated from the order because the order made no finding as to the appropriate price. In the order issued by the APSC, it was reiterated that refunds were not at issue in this docket and that Arkansas Western's gas purchasing practices, affiliate transactions, gas costs and\ngas cost allocation practices were being addressed on a prospective basis only. The Registrant believes the complaint is frivolous. The Company filed on January 19, 1994, a current report on Form 8-K reporting that Vesta Energy Company (\"Vesta\") filed on December 21, 1993, and amended on January 6, 1994, a complaint in the Federal District Court for the Northern District of Oklahoma against the Registrant, four of its subsidiaries, and the NOARK Pipeline System. The complaint makes several allegations and generally claims that the defendants induced Vesta to enter into a contract to transport 50,000 Million British Thermal Units (MMBtu) of gas per day on NOARK and a separate contract to purchase 25,000 MMBtu per day of the total from two of the Registrant's subsidiaries through a series of false representations. On February 17, 1994, Vesta requested permission to amend its complaint a second time to allege anti-trust violations under the Sherman Act. Vesta is seeking rescission of the contracts, actual damages in excess of $1.0 million and punitive damages in excess of $1.0 million. The Registrant believes that Vesta's claim is wholly without merit and in February, 1994, NOARK and the Registrant filed separate lawsuits against Vesta in state and federal courts in Arkansas seeking enforcement of the contracts and damages.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THE REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nSOUTHWESTERN ENERGY COMPANY --------------------------- (Registrant)\nBY: /s/ STANLEY D. GREEN ------------------------ Stanley D. Green, Dated: March 25, 1994 Executive Vice President - Finance and Corporate Development, and Chief Financial Officer\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON MARCH 25, 1994.\n/s/ CHARLES E. SCHARLAU - ------------------------------- Director, Chairman, and Charles E. Scharlau Chief Executive Officer\n/s/ STANLEY D. GREEN Executive Vice President - - ------------------------------- Finance and Corporate Development, Stanley D. Green and Chief Financial Officer\n/s/ GREGORY D. KERLEY Vice President - Treasurer - -------------------------------- and Secretary, and Gregory D. Kerley Chief Accounting Officer\n/s/ E. J. BALL Director - -------------------------------- E. J. Ball\n/s/ JAMES B. COFFMAN Director - -------------------------------- James B. Coffman\n/s/ JOHN PAUL HAMMERSCHMIDT Director - -------------------------------- John Paul Hammerschmidt\n/s/ CHARLES E. SANDERS Director - -------------------------------- Charles E. Sanders\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.\nNot Applicable\nREPORT OF INDEPENDENT AUDITORS ON SUPPORTING SCHEDULES AS OF DECEMBER 31, 1993, 1992, AND 1991 AND FOR THE YEARS THEN ENDED\nTo the Board of Directors and Shareholders of Southwestern Energy Company: We have audited in accordance with generally accepted auditing standards the financial statements included in Southwestern Energy Company's 1993 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 7, 1994. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index above are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nTulsa, Oklahoma February 7, 1994\nSCHEDULE V\nSCHEDULE VI\nSCHEDULE IX\nSCHEDULE X\nEXHIBIT INDEX\nEXHIBIT NO. DESCRIPTION REFERENCE - ------- ----------- --------- 3. Articles of Incorporation and Bylaws of the Company *\n4. Shareholder Rights Agreement, dated May 5, 1989 (v)\nMaterial Contracts:\n10.1 Gas Purchase Contract between SEECO, Inc., and Arkansas Western Gas Company, dated July 24, 1978, and amended May 21, 1979 (i)\n10.2 Agreement between Southwestern Energy Company, Arkansas Western Gas Company, Arkansas Power & Light Company and Associated Natural Gas Company, dated September 1, 1987, as amended February 22, 1988, and May 16, 1988 (iii), (iv)\n10.3 Gas Purchase Contract between SEECO, Inc., and Associated Natural Gas Company, dated October 1, 1990 (vii)\n10.4 Compensation Plans: (a) Summary of Southwestern Energy Company Annual and Long-Term Incentive Compensation Plan, effective January 1, 1985, as amended July 10, 1989, (Replaced by Southwestern Energy Company 1993 Incentive Compensation Plan, effective January 1, 1993. (i), (vi)\n(b) Summary of Southwestern Energy Company 1993 Incentive Compensation Plan, effective January 1, 1993. *\n(c) Nonqualified Stock Option Plan, as amended July 10, 1989 (Replaced by Southwestern Energy Company 1993 Stock Incentive Plan, dated April 7, 1993). (ii)\n(d) Exploration Incentive Plan A, effective January 1, 1988, as amended July 10, 1989. (vi)\n(e) Southwestern Energy Company 1993 Stock Incentive Plan, dated April 7, 1993. (x)\n(f) Southwestern Energy Company 1993 Stock Incentive Plan for Outside Directors, dated April 7, 1993. (x)\n10.5 Southwestern Energy Company Supplemental Retirement Plan, adopted May 31, 1989, and Amended and Restated as of December 15, 1993. *\n10.6 Southwestern Energy Company Supplemental Retirement Plan Trust, dated December 30, 1993. *\n10.7 Executive Severance Agreement for Charles E. Scharlau, effective August 4, 1989. (vi)\n10.8 Executive Severance Agreement for Stanley D. Green, effective August 4, 1989. (vi)\n10.9 Executive Severance Agreement for B. Brick Robinson, effective August 4, 1989. (vi)\n10.10 Executive Severance Agreement for Dan B. Grubb, effective July 8, 1992. (ix)\n10.11 Consulting Agreement between the Company and J. B. Coffman & Associates, Inc., effective November 8, 1989. (vi)\n10.12 Employment Agreement for Charles E. Scharlau, dated December 18, 1990, effective January 1, 1991. (vii)\n10.13 Employment Agreement for Dan B. Grubb, effective July 8, 1992. (ix)\n10.14 Form of Indemnity Agreement, between the Company and each officer and director of the Company, dated May 25, 1988 or October 9, 1991. (iv), (viii)\n10.15 Gas Transportation Agreement between NOARK Pipeline System, Limited Partnership and Arkansas Western Gas Company, dated February 4, 1991, and amended February 14, 1992. (ix)\n10.16 Limited Partnership Agreement of NOARK Pipeline System, Limited Partnership, dated October 10, 1991, and amended February 24, 1993. (viii), (ix)\n10.17 Operating Agreement of NOARK Pipeline System, dated March 19, 1991. (viii)\n10.18 Agreement for Sale of Partnership Interest between Southwestern Energy Pipeline Company and GRUBB NOARK Pipeline, Inc., dated July 24, 1992. (ix)\n13. 1993 Annual Report to Shareholders, except for those portions not expressly incorporated by reference into this report. Those portions not expressly incorporated by reference are not deemed to be filed with the Securities and Exchange Commission as part of this report. *\n22. Subsidiaries of the Registrant. (ix)\n_______________ (i) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1984.\n(ii) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1985.\n(iii) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1987.\n(iv) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1988.\n(v) Incorporated by reference to the exhibit filed with the Company's Form 8-K on May 10, 1989.\n(vi) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1989.\n(vii) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1990.\n(viii) Incorporated by reference to the exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1991.\n(ix) Incorporated by reference to the exhibit filed with the Company's filing on form 10-K for the year ended December 31, 1992.\n(x) Incorporated by reference to the appendix filed with the Company's definitive proxy statement to holders of the Registrant's Common Stock in connection with the solicitation of proxies to be used in voting at the Annual Meeting of Shareholders on May 26, 1993.\n* Exhibit filed with the Company's filing on Form 10-K for the year ended December 31, 1993."},"word_count":{"kind":"number","value":9169,"string":"9,169"},"character_count":{"kind":"number","value":59648,"string":"59,648"}}},{"rowIdx":287,"cells":{"filename":{"kind":"string","value":"47111_1993.txt"},"id":{"kind":"string","value":"47111_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"47111"},"text":{"kind":"string","value":"Item 1.BUSINESS\nHershey Foods Corporation and its subsidiaries (the \"Corporation\") are engaged in the manufacture, distribution and sale of consumer food products. The Corporation, primarily through its Hershey Chocolate U.S.A., Hershey Grocery, Hershey International and Hershey Pasta Group divisions and its subsidiary Hershey Canada Inc., produces and distributes a broad line of chocolate, confectionery, grocery and pasta products.\nThe Corporation was organized under the laws of the State of Delaware on October 24, 1927, as a successor to a business founded in 1894 by Milton S. Hershey.\nIn March 1993, the Corporation purchased certain assets of three Cleveland, Ohio area pasta companies: Ideal Macaroni Company, Il Pranzo D'oro Corporazoine, Inc. and Weiss Noodle Company. In September 1993, the Corporation purchased all of the shares of Sperlari, S.r.l. from Heinz Italia S.p.A. Sperlari manufactures, markets, sells, and distributes a wide range of confectionery products in Italy, including sugar candies and nougat. In October 1993, the Corporation purchased all of the outstanding shares of Overspecht B.V. Through its subsidiaries, this company manufactures and sells chocolate and non-chocolate confectionery products, cookies, biscuits, and ice cream primarily in the Netherlands and Belgium.\nThe Corporation's principal product groups include: chocolate and confectionery products sold in the form of bar goods, bagged items, boxed items, and throat drops; grocery products in the form of baking ingredients, chocolate drink mixes, peanut butter, dessert toppings, and beverages; pasta products sold in a variety of different shapes, sizes and packages; and refrigerated puddings. The Corporation believes it is a major factor in these product groups in North America. Operating profit margins vary considerably among individual products and brands. Generally, such margins on chocolate and confectionery products are greater than those on pasta and other food products.\nThe Corporation manufactures chocolate and confectionery products in a variety of packaged forms and markets them under more than 50 brands. The different packaged forms include various arrangements of the same bar products, such as boxes, trays and bags, as well as a variety of different sizes and weights of the same bar product, such as snack size, standard, king size, large and giant bars. Among the principal chocolate and confectionery products in the United States are: HERSHEY'S COOKIES 'N' MINT chocolate bars, HERSHEY'S HUGS chocolates, HERSHEY'S HUGS WITH ALMONDS chocolates, HERSHEY'S KISSES chocolates, HERSHEY'S KISSES WITH ALMONDS chocolates, HERSHEY'S milk chocolate bars, HERSHEY'S milk chocolate bars with almonds, HERSHEY'S MINIATURES chocolate bars, AMAZIN' FRUIT gummy bears fruit candy, BAR NONE candy bars, CADBURY'S CREME EGGS candy, CARAMELLO candy bars, KIT KAT wafer bars, LUDEN'S throat drops, MR. GOODBAR milk chocolate bars with peanuts, PETER PAUL ALMOND JOY candy bars, PETER PAUL MOUNDS candy bars, REESE'S crunchy peanut butter cups, REESE'S peanut butter cups, REESE'S PIECES candies, ROLO caramels in milk chocolate, SKOR toffee bars, SYMPHONY milk chocolate bars, WHATCHAMACALLIT candy bars, Y&S TWIZZLERS licorice-type candy, YORK peppermint pattie candy, and 5TH AVENUE candy bars.\nThe Corporation also markets a line of grocery products in the baking, beverage, peanut butter, puddings and toppings categories. Principal products include HERSHEY'S baking chocolate, HERSHEY'S baking chips, HERSHEY'S chocolate drink, HERSHEY'S chocolate milk mix, HERSHEY'S cocoa, HERSHEY'S CHOCOLATE SHOPPE toppings, HERSHEY'S syrup, REESE'S peanut butter and REESE'S peanut butter chips. Refrigerated HERSHEY'S chocolate bar flavor puddings are available throughout the United States. HERSHEY'S chocolate milk is produced and sold under license by approximately 25 independent dairies throughout the United States, using a chocolate milk mix manufactured by the Corporation.\nPrincipal products in Canada include CHIPITS chocolate chips, GLOSETTE chocolate-covered raisins, peanuts and almonds, LIFE SAVERS candy, OH HENRY! candy bars, PLANTERS peanuts, POT OF GOLD boxed chocolates, REESE PEANUT BUTTER CUPS candy, and Y&S TWIZZLERS licorice-type candy.\nThe Corporation's chocolate, confectionery and grocery products are sold primarily to grocery wholesalers, chain grocery stores, candy distributors, mass merchandisers, chain drug stores, vending companies, wholesale clubs, convenience stores, concessionaires and food distributors by full-time sales representatives, food brokers and part-time retail sales merchandisers throughout the United States and Canada. The Corporation also manufactures, imports, markets, sells and distributes chocolate products in Mexico under the HERSHEY'S brand name. These products are sold through chain grocery stores, food distributors, and wholesale clubs. The Corporation believes its chocolate and confectionery products are sold in over 2 million retail outlets in North America. Selected products in Canada are sold through a network of independent brokers.\nThe Corporation manufactures, markets, sells and distributes high-quality assorted pralines and seasonal chocolate products in Germany under the GUBOR brand name which are sold directly to retailers. Additionally, the Corporation imports, markets, sells and distributes selected HERSHEY'S chocolate and confectionery products in the Japanese market. In Italy, the Corporation manufactures, markets, sells, and distributes various confectionery and nougat products under several brand names including SPERLARI, DONDI, SCARAMELLINI, FRESH CLUB, SPRINT, GALATINE, and GNAMMY. In the Netherlands and Belgium, the Corporation manufactures and sells chocolate and confectionery products, cookies, biscuits, and ice cream. These products are sold primarily under private labels, but products are also marketed and sold under the WIVER and JAMIN brand names.\nThe Corporation manufactures and sells quality pasta products throughout the United States. The Corporation markets its products on a regional basis under several brand names, including AMERICAN BEAUTY, LIGHT 'N FLUFFY, P&R, RONZONI, SAN GIORGIO, and SKINNER, as well as certain private labels. These products are sold through chain grocery stores, grocery wholesalers, wholesale clubs, convenience stores and food distributors.\nThe Corporation's marketing strategy for its products is based upon the consistently superior quality of its products, mass distribution and the best possible consumer value in terms of price and weight. In addition, the Corporation devotes considerable resources to the identification, development, testing, manufacturing and marketing of new products. The Corporation utilizes a variety of promotional programs for customers and advertising and promotional programs for consumers. The Corporation employs promotional programs at various times during certain seasons of the year to stimulate sales of certain products. Chocolate, confectionery and grocery seasonal and holiday related sales have typically been highest during the third and fourth quarters of the year.\nThe Corporation recognizes that the mass distribution of its consumer food products is an important element in maintaining sales growth and providing service to its customers. The Corporation attempts to meet the changing demands of its customers by planning optimum stock levels and reasonable delivery times consistent with achievement of economies of distribution. To achieve these objectives, the Corporation has developed a distribution network from its manufacturing plants, distribution centers and field warehouses strategically located throughout the United States, Puerto Rico, Canada and Mexico. The Corporation uses a combination of public and contract carriers to deliver its products from the distribution points to its customers. In conjunction with sales and marketing efforts, the distribution system has been instrumental in the effective promotion of new, as well as established, products on both national and regional scales.\nFrom time to time the Corporation has changed the prices and weights of its consumer food products to accommodate changes in the cost of manufacturing, including the cost of raw materials; the competitive environment; and profit objectives, while at the same time maintaining consumer value. The Corporation changes the weight on portions of its standard bar line periodically, and selected weight changes were made in 1993. As a result of higher semolina costs, the Corporation implemented a price increase averaging 3.5% in November 1993 on its pasta products and announced a curtailment of certain promotional allowances effective February 1994.\nThe most significant raw material used in the production of the Corporation's chocolate and confectionery products is cocoa beans. This commodity is imported principally from West African, South American and Far Eastern equatorial regions. West Africa accounts for approximately 60% of the world's crop. Cocoa beans are not uniform, and the various grades and varieties reflect the diverse agricultural practices and natural conditions found in the many growing areas. The Corporation buys a mix of cocoa beans to meet its manufacturing objectives. It attempts to minimize the effect of cocoa bean price fluctuations by the forward purchasing, from time to time, of substantial quantities of cocoa beans, chocolate liquor and cocoa butter, and by the purchase and sale of cocoa futures and options contracts.\nThe table below sets forth annual cocoa prices for each of the calendar years indicated. The prices are the monthly average of the quotations at noon of the three active futures trading contracts closest to maturity on the New York Coffee, Sugar and Cocoa Exchange. Because of the Corporation's forward purchasing practices and premium prices paid for certain varieties of cocoa beans, these average futures contract prices are not necessarily indicative of the Corporation's average cost of cocoa beans or cocoa products.\nCocoa Futures Contract Prices (cents per pound)\n1989 1990 1991 1992 1993\nAverage 54.6 55.5 52.8 47.6 47.3 High 66.8 63.5 60.0 56.2 56.7 Low 42.4 43.6 45.6 41.3 41.8\nSource: International Cocoa Organization Quarterly Bulletin of Cocoa Statistics\nThe price of sugar, the Corporation's second most important commodity for its domestic chocolate and confectionery products, is subject to price supports under farm legislation. Due to import quotas and duties imposed to support the price of sugar established by that legislation, sugar prices paid by United States users are currently substantially higher than prices on the world sugar market. The average wholesale list price of refined sugar, F.O.B. Northeast, has remained relatively stable in a range of 28 cents to 31 cents per pound for the past ten years. The Corporation utilizes forward purchasing and other procurement practices, including, from time to time, the purchase and sale of sugar futures contracts. Therefore, the reported prices of sugar are not necessarily indicative of the Corporation's actual costs.\nOther raw materials purchased in substantial quantities for domestic manufacturing purposes include milk, peanuts, and almonds. The price of milk is affected by Federal Marketing Orders and the prices of milk and peanuts are affected by price support programs administered by the United States Department of Agriculture. The Food, Agriculture, Conservation, and Trade Act of 1990, which is a five-year extension of prior farm legislation, was passed by Congress in October 1990. While this law is not substantially different from the previous farm legislation, it continues to have an impact on the price of sugar, peanuts and milk because it sets price support levels for these and other commodities.\nDuring the first three quarters of 1993, domestic milk prices averaged well below year earlier levels, reflecting strong milk production throughout the country. As a result of the wet weather conditions in the Midwest during the summer, production in the Minnesota-Wisconsin milkshed dropped significantly below the prior year levels in the fourth quarter. For the year, milk prices were not materially different from the 1992 levels.\nAs a result of an excellent 1992 crop harvest, domestic market prices for peanuts were relatively stable through the first three quarters of 1993. However, prices increased modestly during the fourth quarter due to a lower than average 1993 crop harvest.\nDomestic almond prices began 1993 at moderate levels but gradually increased during the first and second quarters due to very low carry-in stocks and lower than average new crop prospects. Prices rose substantially during the third and fourth quarters as the below average 1993 crop was harvested and prices finished the year at a record high.\nPasta is made from semolina milled from durum wheat, a class of hard wheat grown in the United States, principally in North Dakota. The Corporation purchases semolina from commercial millers and also is engaged in custom milling arrangements to obtain sufficient quantities of high quality semolina. A decrease in plantings and adverse weather conditions in the Midwest combined to reduce the quantity and quality of the 1993 durum wheat crop, and resulted in a substantial cost increase for this raw material. Supplies are expected to remain tight at least until the harvest of the new crop during the fall of 1994 and prices may remain at elevated levels in the interim.\nThe Corporation has agreements with Cadbury Beverages Inc. and affiliated companies which license the Corporation to manufacture and/or market and distribute PETER PAUL ALMOND JOY and PETER PAUL MOUNDS confectionery products worldwide as well as YORK, CADBURY and CARAMELLO confectionery products in the United States. The Corporation's rights under these agreements are extendable on a long-term basis at the Corporation's option. The license for CADBURY and CARAMELLO products is subject to a minimum sales requirement which the Corporation substantially exceeded in 1993.\nThe Corporation also has an agreement with Societe des Produits Nestle SA, which licenses the Corporation to manufacture and distribute in the United States the KIT KAT and ROLO confectionery products. The Corporation's rights under this agreement are extendable on a long-term basis at the Corporation's option, subject to certain conditions, including minimum unit volume sales. In 1993, minimum volume requirements were substantially exceeded.\nThe Corporation's products are manufactured and sold in the Philippines pursuant to a technical assistance and trademark licensing agreement. The Corporation manufactures and distributes the SKOR toffee bar in the United States and Canada under a technology license from Freia Marabou a.s of Oslo, Norway.\nThe Corporation has license agreements with Snow Brand Milk Products Co., Ltd. (\"Snow Brand\") of Sapporo, Japan. Snow Brand manufactures and sells in Japan certain beverage and ice cream products under the Corporation's trademarks. The Corporation has a Technical Assistance and Know-How and Trademark License Agreement with Hai-Tai Confectionery Co., Ltd. (\"Hai-Tai\") of Seoul, South Korea. Pursuant to that agreement, Hai-Tai manufactures and sells in the South Korean market certain of the Corporation's chocolate and confectionery products. The Corporation has a license agreement with Maeil Dairy Industry Co., Ltd. (\"Maeil Dairy\") of South Korea. Pursuant to the agreement, Maeil Dairy manufactures, sells and distributes HERSHEY'S chocolate drink and chocolate puddings in South Korea.\nCompetition\nMany of the Corporation's brands enjoy wide consumer acceptance and are among the leading brands sold in the marketplace. However, these brands are sold in highly competitive markets and compete with many other multinational, national, regional and local firms, some of which have resources in excess of those available to the Corporation.\nTrademarks\nThe Corporation has various registered and unregistered trademarks, service marks and licenses which are of material importance to the Corporation's business.\nBacklog of Orders\nThe Corporation manufactures primarily for stock and fills customer orders from finished goods inventories. While at any given time there may be some backlog of orders, such backlog is not material in respect to total sales, nor are the changes from time to time significant.\nResearch and Development\nThe Corporation engages in considerable research activities which principally involve development of new products, improvement of the quality of existing products, and improvement and modernization of production processes. The Corporation also carries out development and evaluation of new processing techniques for both current and proposed product lines.\nRegulation\nThe Corporation's domestic plants are subject to inspection by the Food and Drug Administration and various other governmental agencies, and its products must comply with regulations under the Federal Food, Drug and Cosmetic Act and with various comparable state statutes regulating the manufacturing and marketing of food products.\nEnvironmental Considerations\nIn the past the Corporation has made investments based on compliance with environmental laws and regulations. Such expenditures have not been material with respect to the Corporation's capital expenditures, earnings or competitive position.\nEmployees\nAs of December 31, 1993, the Corporation had approximately 14,300 full-time and 1,600 part-time employees, of whom approximately 6,300 were covered by collective bargaining agreements. The Corporation considers its employee relations to be good.\nItem 2.\n\n\nItem 2. PROPERTIES\nThe following is a list of the Corporation's principal manufacturing properties. The Corporation owns each of these properties.\nUNITED STATES Hershey, Pennsylvania - Confectionery Products (3 principal plants) Oakdale, California - Confectionery Products Stuarts Draft, Virginia - Confectionery Products Winchester, Virginia - Pasta Products\nCANADA Smiths Falls, Ontario - Confectionery and Snack Nut Products\nIn addition to the locations indicated above, the Corporation owns or leases several other less significant properties used for manufacturing confectionery and pasta products, sales, distribution and administrative functions.\nThe Corporation's plants are efficient and well maintained. These plants generally have adequate capacity and can accommodate seasonal demands, changing product mixes and certain additional growth. The largest plant is located in Hershey, Pennsylvania. Many additions and improvements have been made to this facility over the years and the plant's manufacturing equipment includes equipment of the latest type and technology.\nItem 3.\nItem 3. LEGAL PROCEEDINGS\nThe Corporation has no material pending legal proceedings, other than ordinary routine litigation incidental to its business.\nItem 4.\nItem 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nItem 5.\nItem 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation concerning the principal United States trading market for, market prices of and dividends on the Corporation's Common Stock and Class B Common Stock, and the approximate number of stockholders, may be found in the section \"Market Prices and Dividends\" on pages 18 and 19 of the Corporation's 1993 Annual Report to Stockholders, which information is incorporated herein by reference and reproduced herein as Exhibit 13.\nItem 6.\nItem 6. SELECTED FINANCIAL DATA\nThe following information, for the five years ended December 31, 1993, found in the section \"Eleven-Year Consolidated Financial Summary\" on page 40 of the Corporation's 1993 Annual Report to Stockholders, is incorporated herein by reference and reproduced herein as Exhibit 13: Net Sales; Income from Continuing Operations before accounting changes; Income Per Share from Continuing Operations before accounting changes (excluding Notes g and h); Dividends Paid on Common Stock (and related Per Share amounts); Dividends Paid on Class B Common Stock (and related Per Share amounts); Long-term Portion of Debt; and Total Assets.\nItem 7.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe section \"Management's Discussion and Analysis\", found on pages 16 through 19, 21, 23, and 25 of the Corporation's 1993 Annual Report to Stockholders, is incorporated herein by reference and reproduced herein as Exhibit 13.\nItem 8.\n\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following audited consolidated financial statements of the Corporation and its subsidiaries are found at the indicated pages in the Corporation's 1993 Annual Report to Stockholders, and such financial statements, along with the report of the independent public accountants thereon, are incorporated herein by reference and reproduced herein as Exhibit 13.\n1. Consolidated Statements of Income for the years ended December 31, 1993, 1992 and 1991. (Page 20)\n2. Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1992 and 1991. (Page 22)\n3. Consolidated Balance Sheets as of December 31, 1993 and 1992. (Page 24)\n4. Consolidated Statements of Stockholders' Equity for the years ended December 31, 1993, 1992 and 1991. (Page 26)\n5. Notes to Consolidated Financial Statements (Pages 27 through 37), including \"Quarterly Data (Unaudited).\" (Page 37)\n6. Report of Independent Public Accountants. (Page 38)\nItem 9.\nItem 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nItem 10.\n\n\nItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, positions held with the Corporation, periods of service as a director, principal occupations, business experience, and other directorships of nominees for director of the Corporation are set forth in the section \"Election of Directors\" in the Corporation's Proxy Statement for its 1994 Annual Meeting of Stockholders. This information is incorporated herein by reference.\nExecutive Officers of the Corporation as of March 1, 1994\nName Age Positions Held During the Last Five Years\nCORPORATE\nK. L. Wolfe 55 Chairman of the Board and Chief Executive Officer (1993); President and Chief Operating Officer (1985)\nR. A. Zimmerman(1) 61 Retired Chairman of the Board and Chief Executive Officer (1993); Chairman of the Board and Chief Executive Officer (1985)\nJ. P. Viviano 55 President and Chief Operating Officer (1993); President, Hershey Chocolate U.S.A., a division of Hershey Foods Corporation (1985)\nW. F. Christ 53 Senior Vice President and Chief Financial Officer (1994); President, Hershey International, a division of Hershey Foods Corporation (1988)\nC. L. Duncan 54 Vice President, Research and Development (1981)\nT. C. Fitzgerald 54 Vice President and Treasurer (1990); Treasurer (1985)\nS. A. Lambly 53 Vice President, Human Resources (1989)\nW. Lehr, Jr. 53 Vice President and Secretary (1994); Senior Vice President and Secretary and Associate General Counsel (Securities) (1988)\nR. M. Reese 44 Vice President and General Counsel (1993); Assistant General Counsel (1987)\nJ. B. Stiles 42 Vice President and Corporate Controller (1990); Controller and Chief Accounting Officer (1987)\nB. L. Zoumas 51 Vice President, Science and Technology (1992); Vice President, Technical, Hershey Chocolate U.S.A. (1990); Vice President, Science and Technology (1981)\nDIVISION\nJ. F. Carr 49 President, Hershey International (1994); Vice President, Marketing, Hershey Chocolate U.S.A. (1984)\nM. F. Pasquale 46 President, Hershey Chocolate U.S.A. (1994); Senior Vice President and Chief Financial Officer (1988)\nExecutive Officers of the Corporation\nName Age Positions Held During the Last Five Years\nR. W. Meyers 50 President, Hershey Canada Inc., a subsidiary of Hershey Foods Corporation (1990); Acting President, Hershey Canada Inc. (1989)\nC. M. Skinner 60 President, Hershey Pasta Group, a division of Hershey Foods Corporation (1984)\nR. Brace 50 Vice President, Manufacturing, Hershey Chocolate U.S.A. (1987)\nF. Cerminara 45 Vice President, Commodities Procurement, Hershey Chocolate U.S.A. (1994); Vice President, Corporate Development and Commodities (1988)\nD. N. Eshleman(2) 39 General Manager, Hershey Grocery, a division of Hershey Foods Corporation (1994); Director, Marketing, Hershey Chocolate U.S.A. (1988)\nM. H. Holmes(2) 49 Vice President and General Manager, Chocolate Confection, Hershey Chocolate U.S.A. (1994); General Manager, Grocery, Hershey Chocolate U.S.A. (1989)\nM. T. Matthews 47 Vice President, Sales, Hershey Chocolate U.S.A. (1989)\n(1) Mr. Zimmerman retired on December 31, 1993.\n(2) Messrs. Eshleman's and Holmes' positions prior to 1994 were not executive officer positions.\nThere are no family relationships among any of the above named officers of the Corporation.\nCorporate Officers and Division Presidents are generally elected each year at the organization meeting of the Board of Directors following the Annual Meeting of Stockholders in April.\nItem 11.\nItem 11. EXECUTIVE COMPENSATION\nInformation concerning compensation of the five most highly compensated executive officers of the Corporation individually, and compensation of directors, is set forth in the sections \"1993 Executive Compensation\" and \"Compensation of Directors\" in the Corporation's Proxy Statement for its 1994 Annual Meeting of Stockholders. This information is incorporated herein by reference.\nItem 12.\nItem 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation concerning ownership of the Corporation's voting securities by certain beneficial owners, individual nominees for directors, and by management, including the five most highly compensated executive officers, is set forth in the section \"Voting Securities\" in the Corporation's Proxy Statement for its 1994 Annual Meeting of Stockholders. This information is incorporated herein by reference.\nItem 13.\nItem 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning \"Certain Relationships and Related Transactions\" is set forth in the section \"Certain Transactions and Relationships\" in the Corporation's Proxy Statement for its 1994 Annual Meeting of Stockholders. This information is incorporated herein by reference.\nPART IV\nItem 14.\nItem 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nItem 14(a)(1): Financial Statements\nThe audited consolidated financial statements of the Corporation and its subsidiaries and the Report of Independent Public Accountants thereon, as required to be filed with this report, are set forth in Item 8 of this report and are incorporated therein by reference to specific pages of the Corporation's 1993 Annual Report to Stockholders and reproduced herein as Exhibit 13.\nItem 14(a)(2): Financial Statement Schedules\nThe following consolidated financial statement schedules of the Corporation and its subsidiaries for the years ended December 31, 1993, 1992 and 1991 are filed herewith on the indicated pages in response to Item 14(d):\n1. Schedule V--Property, Plant and Equipment (Page 15)\n2. Schedule VI--Accumulated Depreciation of Property, Plant and Equipment (Page 16)\n3. Schedule VIII--Valuation and Qualifying Accounts (Page 17)\n4. Schedule IX--Short-Term Borrowings (Page 18)\nOther schedules have been omitted as not applicable or required, or because information required is shown in the consolidated financial statements or notes thereto.\nFinancial statements of the parent corporation only are omitted because the Corporation is primarily an operating corporation and there are no significant restricted net assets of consolidated and unconsolidated subsidiaries.\nItem 14(a)(3): Exhibits\nThe following items are attached or incorporated by reference in response to Item 14(c):\n(3) Articles of Incorporation and By-laws\nThe Corporation's Restated Certificate of Incorporation, as amended, is incorporated by reference from Exhibit No. 3 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended April 3, 1988. The By-laws, as amended on December 3, 1991, are incorporated by reference from Exhibit No. 3 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(4) Instruments defining the rights of security holders, including indentures\nThe Corporation has issued certain long-term debt instruments, no one class of which creates indebtedness exceeding 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. These classes consist of the following:\na. 8.45% to 9.92% Medium-Term Notes due 1994-1998\nb. 8.8% Debentures due 2021\nc. Other Obligations\nThe Corporation will furnish copies of the above debt instruments to the Commission upon request.\nIn 1993 the Corporation called and redeemed its 9.5% Sinking Fund Debentures due 2009 and its 9.125% Sinking Fund Debentures due 2016.\n(10) Material contracts\na. \"After Eight, Kit Kat, and Rolo License Agreement\" (License Agreement) between Hershey Foods Corporation and Rowntree Mackintosh Confectionery Limited is incorporated by reference from Exhibit No. 10(a) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1980. The License Agreement was amended in 1988 and the Amendment Agreement is incorporated by reference from Exhibit No. 19 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended July 3, 1988. The License Agreement was assigned by Rowntree Mackintosh Confectionery Limited to Societe des Produits Nestle SA as of January 1, 1990. The Assignment Agreement is incorporated by reference from Exhibit No. 19 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\nb. Peter Paul/York Domestic Trademark & Technology License Agreement between Hershey Foods Corporation and Cadbury Schweppes Inc. (now Cadbury Beverages Inc.) dated August 25, 1988, is incorporated by reference from Exhibit No. 2(a) to the Corporation's Current Report on Form 8-K dated September 8, 1988.\nc. Cadbury Trademark & Technology License Agreement among Hershey Foods Corporation and Cadbury Schweppes Inc. (now Cadbury Beverages Inc.) and Cadbury Limited dated August 25, 1988, is incorporated by reference from Exhibit No. 2(a) to the Corporation's Current Report on Form 8-K dated September 8, 1988.\nExecutive Compensation Plans:\nd. The \"1987 Key Employee Incentive Plan\" (the \"Plan\") is incorporated by reference from Exhibit No. 10(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1987. The Plan was amended in 1991, and the amendment is incorporated by reference from Exhibit No. 10 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1991. The Plan was further amended in 1992, and the amendment is incorporated by reference from Exhibit No. 19 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\ne. Hershey Foods Corporation's \"Supplemental Executive Retirement Plan\" is incorporated by reference from Exhibit No. 10(c) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1982.\nf. Hershey Foods Corporation's \"Non-Management Director Retirement Plan\" is incorporated by reference from Exhibit No. 19 to the Corporation's Quarterly Report on Form 10-Q for the quarter ended March 29, 1992.\ng. Hershey Foods Corporation's \"Deferral Plan for Non- Management Directors\" is incorporated by reference from Exhibit No. 10 to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(12) Computation of ratio of earnings to fixed charges statement\nA computation of ratio of earnings to fixed charges for the years ended December 31, 1993, 1992, 1991, 1990, and 1989 is attached as Exhibit No. 12.\n(13) Annual report to security holders\nThe financial section of the Corporation's 1993 Annual Report to Stockholders is attached as Exhibit No. 13.\n(21) Subsidiaries of the Registrant\nA list setting forth subsidiaries of the Corporation is attached as Exhibit No. 21.\nItem 14(b):Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHERSHEY FOODS CORPORATION (Registrant)\nDate: March 7, 1994 By W. F. CHRIST\n(W. F. Christ, Senior Vice President and Chief Financial Officer)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Corporation and in the capacities and on the date indicated.\nSignature Title Date\nK. L. WOLFE Chief Executive Officer March 7, 1994 (K. L. Wolfe) and Director\nW. F. CHRIST Chief Financial Officer March 7, 1994 (W. F. Christ)\nJ. B. STILES Chief Accounting Officer March 7, 1994 (J. B. Stiles)\nJ. P. VIVIANO Director March 7, 1994 (J. P. Viviano)\nH. O. BEAVER, JR. Director March 7, 1994 (H. O. Beaver, Jr.)\nT. C. GRAHAM Director March 7, 1994 (T. C. Graham)\nB. GUITON Director March 7, 1994 (B. Guiton)\nJ. C. JAMISON Director March 7, 1994 (J. C. Jamison)\nS. C. MOBLEY Director March 7, 1994 (S. C. Mobley)\nF. I. NEFF Director March 7, 1994 (F. I. Neff)\nSignature Title Date\nR. J. PERA Director March 7, 1994 (R. J. Pera)\nJ. M. PIETRUSKI Director March 7, 1994 (J. M. Pietruski)\nV. A. SARNI Director March 7, 1994 (V. A. Sarni)\nH. R. SHARBAUGH Director March 7, 1994 (H. R. Sharbaugh)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Hershey Foods Corporation:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Hershey Foods Corporation's 1993 annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14(a)(2) on page 9 are the responsibility of the Corporation's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nNew York, N.Y. January 28, 1994\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated January 28, 1994, included or incorporated by reference in this Form 10-K for the year ended December 31, 1993, into the Corporation's previously filed Registration Statements on Forms S-8 or S-3 (File No. 33-12718, File No. 33-35062, File No. 33-45431, File No. 33-45556 and File No. 33-51089).\nARTHUR ANDERSEN & CO.\nNew York, N.Y. March 7, 1994\nHERSHEY FOODS CORPORATION ANNUAL REPORT ON FORM 10-K\nIndex to Exhibits\nExhibit No.\n12 - Computation of ratio of earnings to fixed charges statement\n13 - Financial section of 1993 Annual Report to Stockholders\n21 - Subsidiaries of the Registrant"},"word_count":{"kind":"number","value":5288,"string":"5,288"},"character_count":{"kind":"number","value":35559,"string":"35,559"}}},{"rowIdx":288,"cells":{"filename":{"kind":"string","value":"764625_1993.txt"},"id":{"kind":"string","value":"764625_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"764625"},"text":{"kind":"string","value":"ITEM 1. Business\nEnserch Exploration Partners, Ltd. (\"EP\"), a Texas limited partnership, was formed in 1985 to succeed to substantially all of the domestic gas and oil exploration and production business of ENSERCH Corporation (\"ENSERCH\"). ENSERCH and an affiliate own more than 99% of the outstanding limited partnership units and the remaining units of slightly more than 800,000, are publicly held.\nEP operates through EP Operating Limited Partnership (\"EPO\"), a Texas limited partnership, in which EP holds a 99% limited partner's interest and the general partners own a 1% interest. Enserch Exploration, Inc. (\"EEI\") is the managing general partner and ENSERCH is the special general partner of EP and EPO.\nEP is engaged in the exploration for and the development, production and marketing of natural gas and crude oil throughout Texas, offshore in the Gulf of Mexico, onshore in the Gulf Coast and Rocky Mountain areas and in various other areas in the United States. Activities include geological and geophysical studies; acquisition of gas and oil leases; drilling of exploratory wells; development and operation of producing properties; acquisition of interests in developed or partially developed properties; and the marketing of natural gas, crude oil and condensate. Production offices are maintained in Dallas, Houston, Athens, Bridgeport, Longview and Midland, Texas.\nEP has no officers, directors or employees. Instead, officers, directors and employees of EEI perform all management and operating functions for EP. At December 31, 1993, EEI employed 382 persons, including 36 geologists, 21 geophysicists and 19 land representatives who investigate prospective areas, generate drilling prospects, review submitted prospects and acquire leasehold acreage in prospective areas. In addition, EEI maintains a staff of 56 engineers and 46 technologists who plan and supervise the drilling and completion of wells, evaluate prospective gas and oil reservoirs, plan the development and management of fields, and manage the daily production of gas and oil.\nSpot-market sales, which include monthly and short-term industrial sales, covered about 70% of 1993 gas sales, compared with 80% in 1992 and 75% in 1991. During 1994, the percentage of gas sold in the spot market is expected to be in the range of 75% to 85%. Approximately 70% of EP's natural-gas sales volumes (75% of gas revenues) for the year ended December 31, 1993 was sold to affiliated customers. In 1993, affiliated revenues include gas sales under new contracts effective March 1, 1993 with Enserch Gas Company covering essentially all gas production not committed under existing contracts. Affiliated purchasers do not have a preferential right to purchase natural gas produced by EP other than under existing contracts.\nSales data are set forth under \"Selected Financial and Operating Data\" in Appendix A to this report.\nFollowing is a summary of EP's exploration and development activity during 1993:\nGulf of Mexico. Offshore exploration provides EP the opportunity to improve its ratio of production to reserve base by the addition of gas wells with relatively higher production rates. This is coupled with ongoing deep- water development projects, which are expected to provide long-term reserves. State-of-the-art technology, including three-dimensional (\"3-D\") seismic, specialized seismic processing, and innovative well completion and production techniques, are being used to help accomplish these objectives.\nMississippi Canyon Block 441, the first development project in the Gulf of Mexico that EP has operated, is indicative of this approach. A 3-D seismic program, prior to field development, confirmed that the majority of the reservoir lies beneath a shipping fairway. A production program was developed that involved drilling highly deviated wells under the shipping fairway, subsea completing the deep-water wells, and tying the wells back to a conventional shallow-water production platform using bundled flowlines. The high-angle wells required special gravel-pack completion techniques. After a year of production, the field has been essentially maintenance free, producing some 70 million cubic feet (\"MMcf\") of natural gas and more than 500 barrels (\"Bbls\") of condensate per day from six wells.\nThe 3-D seismic on Mississippi Canyon Block 441 is being reprocessed, using depth migration and other state-of-the-art techniques to aid in the identification of deeper exploratory targets, which, if successfully drilled, could add to the field reserves. EP has a 37.5% working interest in this project.\nThe Garden Banks Block 388 oil development project remains on schedule, with initial production anticipated by mid-1995. Installation of the offshore facilities, which consist of a subsea template, gathering and sales pipelines, and shallow-water production facilities, will begin by mid-1994. After the rig and all facilities are in place, the three existing wells will be connected, with initial production from the first well expected to be approximately 5 thousand barrels (\"MBbls\") of oil and 5 MMcf of gas per day. Peak daily production from the project is anticipated to be 40 MBbls of oil and 60 MMcf of gas. EP is 100% owner and operator of the Garden Banks Block 388 project.\nAnother prospect delineated by seismic amplitude anomalies lies approximately four miles to the west of Garden Banks Block 388 on Garden Banks Blocks 386/387. If successfully drilled, this prospect could add production to the Block 388 development by incorporating some of the production technology that was utilized on Mississippi Canyon Block 441.\nIn 1994, an offset well to EP's discovery on Green Canyon Block 254 is scheduled to be drilled. The exploratory well, which was drilled in 1991, encountered 11 sands with a combined thickness of more than 360 feet of oil pay. EP has a 25% working interest in this block and a similar working interest in three adjacent blocks believed to be part of the same project.\nOnshore. EP participated in 78 development wells (62 net) in 1993, with the majority completed as gas producers in East Texas. Thirty-six wells were in progress at yearend. In East Texas, EP is positioned in a prolific gas- prone area which, despite its maturity, provides growth opportunities. EP is one of the oldest and most active operators in this basin in East Texas, which includes Opelika, Tri-Cities, Whelan, Willow Springs, North Lansing and Freestone fields.\nIn early 1993, EP initiated a 26-well program in East Texas to accelerate the development of natural-gas reserves from the Travis Peak formation in the Opelika field. The program was targeted to test new techniques for shortening the average life of its reserve base. The project was completed in seven months yielding initial daily per well production rates of up to 1.8 MMcf of gas and 48 Bbls of oil. EP has a 100% working interest in these wells.\nEP performed additional development drilling in the Freestone field, where seven well completions flowed at daily rates ranging from 1.0 MMcf to 2.3 MMcf of gas per well. EP has 50% to 100% working interests in these wells.\nIn the Bralley field in West Texas, the combined daily oil production rate from six wells increased to 800 Bbls from 500 Bbls following production optimization work. EP owns a 50% working interest in each of these wells.\nIn South Texas, seven wells drilled and completed in the Fashing field flowed at daily rates of 1.2 MMcf to 2.6 MMcf of gas and 14 Bbls to 30 Bbls of oil per well. Twelve wells drilled and completed in the Boonsville field in north central Texas resulted in daily production of .4 MMcf to 1.5 MMcf of gas per well.\nOnshore development activity planned for 1994 includes drilling approximately 35 wells outside East Texas. Some of the larger projects include wells in the Fashing, Rancho Viejo and Boonsville fields.\nIn the Fashing field, results of three wells and a field study indicate development potential for new wells, as well as recompletions that could result in reserve additions.\nCompetition\nCompetition in the natural gas and oil exploration and production business is intense and is present from a large number of firms of varying sizes and financial resources, some of which are much larger than EP. Competition involves all aspects of marketing products (including terms, prices, volumes and length of contracts), terms relating to lease bonus and royalty arrangements, and the schedule of future development activity.\nRegulation\nEnvironmental Protection Agency (\"EPA\") rules, regulations and orders affect the operations of EP. EPA regulations promulgated under the Superfund Amendments and Reauthorization Act of 1986 require EP to report on locations and estimates of quantities of hazardous chemicals used in EP's operations. The EPA has determined that most gas and oil exploration and production wastes are exempt from the hazardous waste management requirements of the Resource Conservation Recovery Act. However, the EPA determined that certain exploration and production wastes resulting from the maintenance of production equipment and transportation are not exempt, and these wastes must be managed and disposed of as hazardous waste. Also, regulations issued by the EPA under the Clean Water Act require a permit for \"contaminated\" stormwater discharges from exploration and production facilities.\nMany states have issued new regulations under authority of the Clean Air Act Amendments of 1990, and such regulations are in the process of being implemented. These regulations may require certain gas and oil related installations to obtain federally enforceable operating permits and may require the monitoring of emissions; however, the impact of these regulations on EP is expected to be minor.\nSeveral states have adopted regulations on the handling, transportation, storage, and disposal of naturally occurring radioactive materials that are found in gas and oil operations. Although applicable to certain EP facilities, it is not believed that such regulations will materially impact current or future operations.\nIn the aggregate, compliance with federal and state environmental rules and regulations is not expected to have a material effect on EP's operations.\nThe Railroad Commission of Texas (\"RRC\") regulates the production of natural gas and oil by EP in Texas. Similar regulations are in effect in all states in which EP explores for and produces natural gas and oil. These regulations generally require permits for the drilling of gas and oil wells and regulate the spacing of the wells, the prevention of waste, the rate of production, and the prevention and cleanup of pollution and other materials.\nITEM 2.\n\n\nITEM 2. Properties\nThe following table sets forth a summary of certain information relating to EP's gas and oil properties:\nThe 1994 capital spending budget has been set at $114 million, about the same as 1993 actual capital expenditures. More than half of the 1994 capital expenditures is earmarked for domestic onshore drilling. The exploration program includes a balanced mix of projects with regard to reserve potential\nand risk, focusing on as many core area opportunities as possible. See \"Financial Review - Capital Resources and Liquidity\" included in Appendix A to this report.\nDuring 1993, Enserch Exploration filed Form EIA-23 with the Department of Energy reflecting reserve estimates for the year 1992. Such reserve estimates were not materially different from the 1992 reserve estimates reported in Note 7 of the Notes to Consolidated Financial Statements included in Appendix A to this report.\nA summary of EP's average sales prices, average production costs and amortization are set forth under \"Selected Financial and Operating Data\" included in Appendix A to this report.\nEP owned leasehold interests or licenses in 17 states and offshore Texas and Louisiana, as of December 31, 1993, as follows:\nThe number of wells drilled is not a significant measure or indicator of the relative success or value of a drilling program because the significance of the reserves and economic potential may vary widely for each project. It is also important to recognize that reported completions may not necessarily track capital expenditures, since Securities and Exchange Commission guidelines do not allow a well to be reported as complete until it is ready for production. In the case of offshore wells, this may be several years following initial drilling because of construction of platforms, pipelines and other necessary facilities.\nAdditional information relating to the gas and oil activities of EP is set forth in Note 7 of the Notes to Financial Statements appearing in Appendix A to this report.\nITEM 3.\nITEM 3. Legal Proceedings\nThe information required hereunder is set forth in Note 5 of the Notes to Financial Statements in Appendix A to this report.\nITEM 4.\nITEM 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nPART II\nITEM 5.\nITEM 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe information required hereunder is set forth under \"Depositary Unit Market Prices and Distribution Information\" set forth in Appendix A to this report.\nITEM 6.\nITEM 6. Selected Financial Data\nThe information required hereunder is set forth under \"Selected Financial and Operating Data\" set forth in Appendix A to this report.\nITEM 7.\nITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe information required hereunder is set forth under \"Financial Review\" included in Appendix A to this report.\nITEM 8.\n\nITEM 8. Financial Statements and Supplementary Data\nThe information required hereunder is set forth under \"Independent Auditors' Report,\" \"Management Report on Responsibility for Financial Reporting,\" \"Statements of Operations,\" \"Statements of Cash Flows,\" \"Balance Sheets,\" \"Statements of Changes in Partners' Capital\" and \"Notes to Financial Statements\" included in Appendix A to this report.\nITEM 9.\nITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.\n\n\nITEM 10. Directors and Executive Officers of the Registrant\nSet forth below is information concerning the directors and executive officers of EEI and directors of ENSERCH who are involved with the conduct of operations of EP. Presently, all directors of EEI and ENSERCH are elected annually.\nDirectors of ENSERCH\nD. W. Beigler, age 47, is Chairman and President, Chief Executive Officer of ENSERCH. Prior to his election to his present position in 1993, he served Lone Star Gas Company, the utility division of the Corporation, as President from 1985 and as Chairman from 1989 and was elected President and Chief Operating Officer of the Corporation in 1991. Mr. Biegler is a Director of ENSERCH, Texas Commerce Bancshares, Inc. and Trinity Industries, Inc. He has been a Director of ENSERCH since 1991.\nW. C. McCord, age 65, is retired Chairman and Chief Executive Officer of ENSERCH. Mr. McCord is a Director of Lone Star Technologies, Inc., and Pool Energy Services Co. He has been a Director of ENSERCH since 1970.\nPreston M. Geren, Jr., age 70, is an investor active in real estate, oil and gas, and banking. He was formerly the owner of Geren Associates, Architects, Engineers & Planners. Mr. Geren has been a Director of ENSERCH\nsince 1973 and serves as Chairman of the Audit Committee and is a member of the Policy and Conflicts of Interest Committee. He is a Director of Overton Bancshares, Inc., Overton Bank & Trust Co., Pool Energy Services Co., and Cassco Development Corporation.\nW. Ray Wallace, age 71, is Chairman, President and Chief Executive Officer, and Director, Trinity Industries, Inc., a fabricated steel products company. Mr. Wallace has been a Director of ENSERCH since 1978 and serves as Chairman of the Compensation Committee and is a member of the Audit Committee. He is a Director of Lomas Financial Corporation.\nWilliam B. Boyd, age 70, is retired Chairman of the Board, President and Chief Executive Officer, American Standard Inc., a manufacturer of air conditioning, building, and transportation products. Mr. Boyd has been a Director of ENSERCH since 1984 and serves as Chairman of the Nominating Committee and is a member of the Compensation Committee. Mr. Boyd is a Director of Armco Inc. and FMC Corporation.\nB. A. Bridgewater, Jr., age 60, is Chairman, President and Chief Executive Officer, and Director, Brown Group, Inc., a consumer products company with operations in footwear and specialty retailing. Mr. Bridgewater has been a Director of ENSERCH since 1987 and serves as Chairman of the Policy and Conflicts of Interest Committee and is a member of the Audit Committee. He is a Director of Boatmen's Bancshares, Inc., FMC Corporation, and McDonnell Douglas Corporation.\nJ. M. Haggar, Jr., age 69, is retired Chairman of the Board, and Director, Haggar Apparel Company, a manufacturer of apparel for men. Mr. Haggar has been a Director of ENSERCH since 1988 and is a member of the Directors' Nominating Committee and the Policy and Conflicts of Interest Committee. He is a Director of Brinker International, Inc.\nDr. L. E. Fouraker, age 70, is retired from the position of Dean of the Harvard Business School. Dr. Fouraker has been a Director of ENSERCH since 1990 and is member of the Compensation Committee and the Directors' Nominating Committee. He is a Director of Alcan Aluminum Limited, Citicorp, General Electric Company, Gillette Company, Ionics, Inc., and The New England.\nM. J. Girouard, age 54, is President and Chief Operating Officer, and Director, Pier 1 Imports, Inc. Mr. Girouard has been a Director of ENSERCH since 1992 and is a member of the Compensation Committee and the Directors' Nominating Committee.\nDr. Diana S. Natalicio, age 54, is President, University of Texas at El Paso. Dr. Natalicio has been in her present position since 1988. She is a Director of Lomas Financial Corporation and Sandia Corporation.\nThe Policy and Conflicts of Interest Committee of ENSERCH reviews areas of potential conflict between EP and ENSERCH, its subsidiaries and affiliates (\"ENSERCH\" companies) and takes such action as it deems appropriate in order to provide reasonable assurances of fair dealings between such entities. The Committee meets at least annually, and more frequently if necessary.\nITEM 11.\nITEM 11. Executive Compensation\nThe total amount of compensation paid by EEI to all its executive officers for the year ended December 31, 1993, which was charged to EP, was $500,129 (2 persons). The amounts paid include base salary, bonus and other miscellaneous earnings categories. The directors of EEI are not compensated in their capacities as directors.\nITEM 12.\nITEM 12. Security Ownership of Certain Beneficial Owners and Management\nAs of March 9, 1994:\nName and Address of Beneficial Owner Amount and Nature Percent of Depositary Units of Beneficial Ownership of Class - -------------------- ----------------------- ----------\nENSERCH Corporation 101,694,162 Indirect 99.2(1) 300 South St. Paul Street Dallas, Texas 75201 - ------------ (1) Includes 98,581,800 units representing limited partnership interests held by an affiliate, Enserch Processing Partners, Ltd., which may be exchanged at any time for Depositary Units of EP. No Directors or Officers of ENSERCH or EEI own any units.\nITEM 13.\nITEM 13. Certain Relationships and Related Transactions\nEP commenced operations in 1985 following the transfer to it of substantially all of the domestic gas and oil exploration and production business of ENSERCH. For a description of the transactions and properties involved in the transfer, see \"Business\", \"Properties\" and Notes to Financial Statements in Appendix A to this report.\nFor information concerning related party transactions between EP and ENSERCH (including its affiliates), see \"Directors and Executive Officers of Registrant-Directors of ENSERCH\" and the Notes to Financial Statements in Appendix A to this report.\nPART IV\nITEM 14.\nITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)-1 Financial Statements\nThe following items appear in the Financial Information section included as Appendix A to this report:\nItem Page ----- ----\nSelected Financial and Operating Data. . . . . . . . . . . . . . . A-2 Financial Review . . . . . . . . . . . . . . . . . . . . . . . . . A-3 Independent Auditors' Report . . . . . . . . . . . . . . . . . . . A-7 Management Report on Responsibility for Financial Reporting. . . . A-8 Financial Statements: Statements of Operations . . . . . . . . . . . . . . . . . . . A-10 Statements of Cash Flows . . . . . . . . . . . . . . . . . . . A-11 Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . A-12 Statements of Changes in Partners' Capital . . . . . . . . . . A-13 Notes to Financial Statements. . . . . . . . . . . . . . . . . . . A-14 Depositary Unit Market Prices and Distribution Information . . . . A-25\n(a)-2 Financial Statement Schedules\nThe following items are included in Appendix B to this report:\nItem Page ---- ----\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . . . B-2 Financial Statement Schedules for the Three Years Ended December 31, 1993: IV -Indebtedness to Related Parties . . . . . . . . . . B-3 V -Property, Plant and Equipment . . . . . . . . . . . B-4 VI -Accumulated Depreciation and Amortization of Property, Plant and Equipment . . . . . . . . . . . B-5 X -Supplementary Statements of Operations Information . . . . . . . . . . . . . . . . . . . . B-6\nThe financial statement schedules, other than those listed above, are omitted because of the absence of the conditions under which they are required or because the required information is included in the financial statements or notes thereto.\n(a)-3 Exhibits\n4.1* - Agreement of Limited Partnership of EP and amendment No. 1 thereto as currently in effect, filed as Exhibit 4.1 to Registrant's Form 10-K for the fiscal year ended December 31, 1992.\n4.2* - Form of Certificate for Limited Partner's Units of EP filed as Exhibit 3.2 and included as Annex I to Exhibit B to the Prospectus included in Registration Statement No. 2-96373.\n4.3* - Agreement of Limited Partnership of EPO and amendments No. 1 and No. 2 thereto currently in effect, filed as Exhibit 4.3 to Registrant's Form 10-K for the fiscal year ended December 31, 1992.\n4.4* - Depositary Agreement among EP, Harris Trust Company of New York as the Depositary and the Unitholders, relating to EP Depositary Units, filed as Exhibit 4.1 to Registration Statement No. 2- 96373.\n4.5* - Form of Specimen Depositary Receipt filed as Exhibit 4.2 to Registration Statement No. 2-96373.\n10.1*- Assignment and Conveyance from EP Operating Limited Partnership \"Grantor\" to Encogen One Partners, Ltd. \"Grantee\" dated February 29, 1988, filed as Exhibit 10.1 to Registrant's Form 10-K for the fiscal year ended December 31, 1987.\n23** - Consent of DeGolyer and MacNaughton.\n24** - Powers of Attorney - ------------ * Incorporated and herein by reference made a part hereof. ** Filed herewith\n(b) No reports on Form 8-K were filed during the three months ended December 31, 1993.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized:\nENSERCH EXPLORATION PARTNERS, LTD. (A Texas Limited Partnership):\nBy: ENSERCH EXPLORATION, INC. Managing General Partner\nMarch , 1994 By /s/ D. W. Biegler ---------------------- D. W. Biegler, Chairman\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the date indicated.\nSignature and Title Date ------------------ ------\nD. W. Biegler, Chairman, Chief Executive Officer and Director; Gary J. Junco, President, Chief Operating Officer and Director; R. L. Kincheloe, Senior Vice President, Offshore and International, March , 1994 and Director; W. T. Satterwhite, Director; S. R. Singer, Director; and J. W. Pinkerton, Vice President and Controller\nBy: /s/ D. W. Biegler D. W. Biegler As Attorney-in-Fact\nAPPENDIX A\nENSERCH EXPLORATION PARTNERS, LTD. INDEX TO FINANCIAL INFORMATION December 31, 1993\nPage\nSelected Financial and Operating Data. . . . . . . . . . . . . . . . . . A-2\nFinancial Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-3\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . A-7\nManagement Report on Responsibility for Financial Reporting. . . . . . . A-8\nFinancial Statements:\nStatements of Operations. . . . . . . . . . . . . . . . . . . . A-10\nStatements of Cash Flows. . . . . . . . . . . . . . . . . . . . A-11\nBalance Sheets. . . . . . . . . . . . . . . . . . . . . . . . . A-12\nStatements of Changes in Partners' Capital. . . . . . . . . . . A-13\nNotes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . A-14\nDepositary Unit Market Prices and Distribution Information . . . . . . . A-25\nA-1\nA-2\nENSERCH EXPLORATION PARTNERS, LTD. FINANCIAL REVIEW\nRESULTS OF OPERATIONS\nEP had a net loss of $4 million in 1993, compared with a loss of $20 million in 1992 and a loss of $50 million in 1991. The 1992 loss included a $16 million write-off of an idle pipeline and shallow-water production facility from an abandoned offshore project, and 1991 results included a $51 million noncash charge for a write-down under the \"ceiling test\" for the \"full cost\" method of accounting. Excluding the write-downs, EP's 1993 net loss was about the same as in 1992 and compares with income of $1.8 million in 1991.\nExcluding the write-downs, operating income for 1993 was $26 million versus $16 million in 1992 and $21 million in 1991. The improvement resulted from significantly increased natural-gas prices and higher sales volumes. Revenues for 1993 of $185 million were 12% higher than 1992 and 6% above 1991.\nNatural-gas revenues were $145 million, compared with $117 million for 1992 and $122 million for 1991. The average natural-gas price per thousand cubic feet (Mcf) in 1993 was $2.09, up 15% from $1.82 in 1992 and 19% from $1.76 in 1991. Natural-gas sales volumes in 1993 of 69 billion cubic feet increased 7% from the 1992 level and were virtually the same as in 1991. The increase in volumes for 1993 was principally due to accelerated natural-gas development drilling in East Texas and offshore production from Mississippi Canyon Block 441 in the Gulf of Mexico, which went on stream in the second quarter of 1993.\nSpot-market sales, which include monthly and short-term industrial sales, covered about 70% of 1993 gas sales, compared with 80% in 1992 and 75% in 1991. During 1994, the percentage of gas sold in the spot market is expected to be in the range of 75% to 85%.\nOil revenues were $34 million in 1993, compared with $41 million in 1992 and $49 million in 1991. The average sales price per barrel for 1993 of $17.20 was 10% below 1992 and 16% under 1991. Oil sales volumes for 1993 were 2.0 million barrels (MMBbls), an 8% decline from the 1992 level which was down 11% from the 1991 level. The lower volumes in 1993 were primarily the result of declining production from several North Texas reservoirs.\nExcluding the previously noted write-downs, costs and expenses for 1993 were $159 million, compared with $150 million in 1992 and $153 million in 1991. The increase in expenses for 1993 reflects provisions totaling $7.1 million for pending litigation. Also, depreciation and amortization expense for 1993 of $77 million was $1.6 million higher than 1992, primarily due to increased production. The overall rate of amortization was $.91 per million British thermal units (MMBtu) produced for both 1993 and 1992, compared with $.83 in 1991. Costs of additional offshore projects and increased development costs associated with older East Texas fields largely account for the increase from 1991. Average production cost per MMBtu in 1993 was $.54, compared with $.53 in 1992 and $.56 in 1991.\nA-3\nInterest expense in 1993 of $30 million was approximately $10 million higher than both 1992 and 1991. The increase reflects a $6 million provision for interest due royalty owners. A higher level of debt and less interest capitalized also contributed to the 1993 increase.\nEP's natural-gas reserves at January 1, 1994, were 1.09 trillion cubic feet (Tcf), compared with 1.10 Tcf the year earlier, as estimated by DeGolyer and MacNaughton, independent petroleum consultants. Oil and condensate reserves, including natural gas liquids attributable to leasehold interest, were 38 MMBbls, virtually the same as the year-ago level.\nAt January 1, 1994, estimated future net cash flows from EP's owned proved gas and oil reserves, based on average prices and contracts in effect in December 1993, were $2.0 billion, about the same as the year earlier. The net present value of such cash flows, discounted at the Securities and Exchange Commission (SEC)-prescribed 10%, was $1.1 billion, virtually the same as the prior year. These discounted cash flow amounts are the basis for the SEC-prescribed cost- center ceiling under the full-cost accounting method. The margin between the cost-center ceiling and the unamortized capitalized costs of U.S. gas and oil properties was approximately $150 million at December 31, 1993. Product prices are subject to seasonal and other fluctuations. A significant decline in prices from yearend 1993 or other factors, without mitigating circumstances, could cause a future write-down of capitalized costs and a noncash charge against earnings.\nCAPITAL RESOURCES AND LIQUIDITY\nNet cash flows from operating activities in 1993 were $76 million, $12 million lower than 1992 primarily due to less cash provided by changes in net current operating assets and liabilities, and were virtually the same as in 1991. Investing activities required net cash flows of $124 million, compared with $69 million in 1992 and $105 million in 1991. The increase in 1993 is primarily due to a higher level of capital spending for natural-gas and oil exploration and development programs.\nIn 1993, $48 million was required for investing activities after cash provided by operations, and cash of $31 million was required for the payment of distributions to unitholders. The total requirement of $79 million was provided by an increase in borrowings from affiliated companies and advances under leasing arrangements that temporarily exceeded disbursements for the facilities under construction.\nEP has budgeted $114 million for additions to property, plant and equipment in 1994, compared with expenditures of $113 million in 1993. In 1992, EP's capital spending was sharply curtailed to $63 million in response to poor prices for both natural gas and oil. If the early 1994 weakness in oil prices persists throughout 1994, appropriate cutbacks in spending may be undertaken. More than half of EP's 1994 capital expenditures is earmarked for domestic onshore drilling.\nIn 1992, EP entered into operating lease arrangements to provide financing for its portion of the offshore platforms and related facilities for the Mississippi Canyon Block 441 (37.5% owned) and Garden Banks Block 388 (100% owned) projects. A total of $34 million was required for the Mississippi Canyon Block 441 project, which was completed in early 1993. The lease arrangement to\nA-4\nfund the construction costs for the Garden Banks facility is estimated to total $235 million when completed in 1995. (See Note 5)\nOn January 3, 1994, EP paid a quarterly distribution of $.075 per unit. In February 1994, EP announced that the quarterly distributions to unitholders had been indefinitely suspended.\nEven though inflation has abated considerably from the levels of the early 1980s, and was only about 2.5% in 1993, it continues to have some influence on EP's operations. Most notable is that allowances for depreciation and amortization based on the historical cost of fixed assets may be insufficient to cover the replacement of some long-lived fixed assets.\nThe impact of the Clean Air Act Amendments of 1990 (Act) on EP cannot be fully ascertained until the regulations that implement that Act have been approved and adopted. Management currently believes that operating costs that will be incurred under the new permit fee structure, any capital expenditures associated with equipment modifications, and any other miscellaneous permitting costs required under the Act will not have a material adverse effect on EP's results of operations. Management expects the provisions of the Act will increase the attractiveness of natural gas as compared with certain alternative fuels; however, it is impossible to quantify any increase in demand for natural gas, if any, that may be created by the Act.\nFOURTH-QUARTER RESULTS\nEP had a net loss of $6.5 million for the fourth quarter of 1993, compared with a loss of $16 million for the 1992 fourth quarter, which included the $16 million write-off of the abandoned offshore facilities. Excluding the write- off, operating income for the fourth quarter was $4.8 million versus $6.2 million for the same period of 1992. Revenues in 1993 of $50 million were 14% greater than 1992 primarily due higher natural-gas revenues resulting from a 24% increase in sales volumes. The average natural-gas sales price for the fourth quarter of $2.22 per Mcf was about the same as the prior year. Operating expenses and interest expense were both higher than in the prior year due to the previously noted provisions for pending litigation and interest due royalty owners.\nDRILLING PROGRAM\nDrilling activity during the first half of 1993 increased to levels last experienced in 1987, primarily because of development work in East Texas. EP participated in 109 wells (79 net) in 1993, with the majority completed as gas producers in East Texas. Thirty-six wells were in progress at yearend. Recompletions and production optimization measures had a major role in the 1993 production enhancement program.\nResults for 1994 will include a full year of production from the Mississippi Canyon Block 441 deep-water project in the Gulf of Mexico, which began production in early 1993. The field is producing some 70 million cubic feet (MMcf) of natural gas and more than 500 barrels of condensate per day from six wells. EP is the operator, with a 37.5% working interest in the project.\nA-5\nThe Garden Banks Block 388 oil development project, also in the Gulf, remains on schedule and on budget, with initial production anticipated by mid- 1995. The final major contract for the conversion of a semi-submersible drilling rig to a floating production facility was finalized in early 1994. Installation of the offshore facilities, consisting of the subsea template, gathering and sales pipelines and shallow-water operations, will begin by mid-year. Three previously drilled oil wells will be connected to the subsea template in 1995. Initial daily production from three predrilled wells is expected to total 15 thousand barrels (MBbls) of oil and 12 to 15 MMcf of gas by late 1995, with peak daily production from the Garden Banks project anticipated in late 1996 at 40 MBbls of oil and 60 MMcf of gas. Gross proven reserves are presently estimated to be equivalent to 28 MMBbls of oil by DeGolyer and MacNaughton. EP is 100% interest owner and operator of the Garden Banks project.\nNEW ACCOUNTING STANDARDS\nSFAS No. 106, \"Employer's Accounting for Postretirement Benefits Other than Pensions,\" which mandates the accounting for medical and life insurance and other nonpension benefits provided to retired employees, was adopted by EP effective January 1, 1993. (See Note 2)\nSFAS No. 112, \"Employer's Accounting for Postemployment Benefits,\" will become effective for EP in 1994. This standard covers the accounting for estimated costs of benefits provided to former or inactive employees before their retirement. EP receives an allocation of these benefits from ENSERCH which currently accrues costs of benefits to former or inactive employees by varying methods. The new standard is not expected to have a significant effect on results of operations or financial condition.\nA-6\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Enserch Exploration Partners, Ltd.:\nWe have audited the accompanying balance sheets of Enserch Exploration Partners, Ltd. as of December 31, 1993 and 1992, and the related statements of operations, cash flows and changes in partners' capital for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, such financial statements present fairly, in all material respects, the financial position of the Partnership at December 31, 1993 and 1992, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE\nDallas, Texas February 7, 1994\nA-7\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Enserch Exploration, Inc. (a wholly owned subsidiary of ENSERCH), as Managing General Partner of Enserch Exploration Partners, Ltd., is responsible for the preparation, presentation and integrity of the financial statements. These statements have been prepared in conformity with accounting principles generally accepted in the United States and include amounts that represent management's best estimates and judgments. Management has established practices and procedures designed to support the reliability of the estimates and minimize the possibility of a material misstatement. Management also is responsible for the accuracy of the other information presented in the annual report on Form 10-K and for its consistency with the financial statements.\nManagement has established and maintains internal accounting controls that provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees with significant roles in the financial reporting process and updated as necessary. Management continually monitors compliance with the system of internal accounting controls. ENSERCH maintains a strong internal audit function that evaluates the adequacy of the system of internal accounting controls. As part of the annual audit of the financial statements, Deloitte & Touche also performs a study and evaluation of the system of internal accounting controls as necessary to determine the nature, timing and extent of their auditing procedures. The Board of Directors of ENSERCH maintains an Audit Committee composed of Directors who are not employees. The Audit Committee meets periodically with management, the independent auditors and the internal auditors to discuss significant accounting, auditing, internal accounting control and financial reporting matters. A procedure exists whereby either the independent auditors or the internal auditors through the independent auditors may request, directly to the Audit Committee, a meeting with the Committee.\nManagement has given proper consideration to the independent and internal auditors' recommendations concerning the system of internal accounting controls and has taken corrective action believed appropriate in the circumstances. Management further believes that, as of December 31, 1993, the overall system of internal accounting controls is sufficient to accomplish the objectives discussed herein.\nA-8\nManagement recognizes its responsibility for establishing and maintaining a strong ethical climate so that the Partnership's affairs are conducted according to the highest standards as defined in ENSERCH's Statement of Policies. The Statement of Policies is publicized throughout ENSERCH and addresses, among other issues, open communication within ENSERCH; the disclosure of potential conflicts of interest; compliance with the laws, including those relating to financial disclosures; and the confidentiality of proprietary information.\nEnserch Exploration, Inc. Managing General Partner of Enserch Exploration Partners, Ltd.\n/s/ Gary J. Junco - ------------------ Gary J. Junco President, Chief Operating Officer\n/s/J. W. Pinkerton - ------------------ J. W. Pinkerton Vice President and Controller\nA-9\nA-10\nA-11\nA-12\nA-13\nENSERCH EXPLORATION PARTNERS, LTD. NOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION AND CONTROL\nEnserch Exploration Partners, Ltd. (\"EP\"), a Texas limited partnership, was formed in 1985 to succeed to substantially all of the domestic gas and oil exploration and production business of ENSERCH Corporation (\"ENSERCH\"). At December 31, 1993, ENSERCH and Enserch Processing Partners, Ltd. (\"Processing\") owned 3,112,362 (3.0%) and 98,581,800 (96.2%), respectively, of EP's limited partnership units outstanding. The balance of 805,914 (.8%) of EP's units outstanding is held by the public. For administrative convenience, EP operates through EP Operating Limited Partnership (\"EPO\"), formerly EP Operating Company, a Texas limited partnership, in which EP holds a 99% limited partner's interest and the general partners own a 1% interest. Enserch Exploration, Inc. (\"EEI\") is the managing general partner and ENSERCH is the special general partner of EP and EPO.\nEP has no officers, directors or employees. Instead, officers, directors and employees of EEI perform all management and operating functions for EP. Neither ENSERCH nor EEI, as general partners of EP, receives any carried interests, promotions, back-ins or other compensation.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation - The financial statements of EP have been prepared in conformity with generally accepted accounting principles but will not be the basis for reporting taxable income to unitholders. The proportional consolidation method is used whereby the financial statements reflect EP's 99% interest in EPO's assets, liabilities and operations. All dollar amounts except per unit amounts in the notes to financial statements are stated in thousands unless otherwise indicated.\nNatural Gas and Oil Hedging Contracts - Gains and losses from transactions to hedge against volatile product prices are included in revenues in the statements of operations.\nGas and Oil Properties - The full-cost method, as prescribed by the Securities and Exchange Commission (SEC), is used whereby the costs of proved and unproved gas and oil properties, together with successful and unsuccessful exploration and development costs, are capitalized. The carrying value is limited to the present value of estimated future net revenues of proved reserves, the cost of excluded properties and the lower of cost or market value of unproved properties being amortized (\"full-cost ceiling\"). The full-cost ceiling is calculated quarterly under current SEC rules. In March 1991, EP recorded a $51 million noncash write-down of the carrying value of its gas and oil properties due to the full-cost center ceiling limitation test.\nDry-hole costs resulting from exploration activities are classified as evaluated costs and are included in the amortization base. Costs directly associated with the acquisition and evaluation of unproved properties are excluded from the amortization base until the related properties are evaluated. Such unproved properties are assessed periodically and a provision for impairment is made to the full-cost amortization base when appropriate. Sales of gas and oil properties are credited to capitalized costs unless the sale would have a significant impact on the amortization rate.\nA-14\nIn December 1992, EP recorded a $16 million noncash write-off of an idle pipeline and shallow-water production facility from an abandoned offshore project.\nDepreciation and Amortization - Amortization of evaluated gas and oil properties is computed on the unit-of-production method using estimated proved gas and oil reserves quantified on the basis of their equivalent energy content. Depreciation of other property, plant and equipment is provided principally by the straight-line method over the estimated service lives of the related assets.\nIncome Taxes - EP is a partnership and, as a result, the income or loss of the partnership, which reflects differences in the timing of the deduction of certain gas and oil drilling and development costs for federal income tax purposes, is includable in the tax returns of the individual partners. Accordingly, no recognition has been given to income taxes in the financial statements of EP. The assets and liabilities reported in the financial statements of EP exceeded the federal income-tax bases by approximately $704 million and $720 million at December 31, 1993 and 1992, respectively.\nRetirement Plan - Substantially all personnel who are associated with EP are covered by an ENSERCH retirement plan and are eligible for certain health care and life insurance benefits upon retirement. Total pension costs allocated to EP were $867, $1,054, and $929 in 1993, 1992 and 1991, respectively. Post-retirement health care and life insurance benefit costs allocated to EP were $821, $550, and $577 in 1993, 1992 and 1991, respectively. Postretirement benefits in 1993 reflect the impact of SFAS No. 106 \"Employer's Accounting for Postretirement Benefits Other Than Pensions\", effective in January 1993. This new standard requires the accrual of these benefits over the working life of the employee rather than charging to expense on a cash basis.\nFair Value of Financial Instruments - The fair value of financial instruments has been estimated using valuation methodologies in accordance with SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments\". Determinations of fair value are based on subjective data and significant judgment relating to timing of payments and collections and the amounts to be realized. Accordingly, the estimates presented are not necessarily indicative of the amounts that EP could realize in a current market exchange.\nManagement believes that the fair value of financial instruments, other than long-term debt, is not materially different than the related carrying value. The estimated fair value for long-term debt is presented in Note 3.\nA-15\n3. LINE OF CREDIT AND BORROWINGS\nShort-term Borrowing Arrangements - Both EP and EPO maintain separate short-term borrowing arrangements with ENSERCH to meet operating needs. Under these arrangements, ENSERCH may advance funds to EP or EPO, and EP or EPO may advance funds to ENSERCH. EPO further maintains a short-term borrowing arrangement with EEI by which EEI may advance funds to EPO and EPO may advance funds to EEI. Under all these arrangements, the aggregate amount of short-term loans available between the parties is at the respective lender's sole discretion, and any amounts advanced under the arrangements mature within 12 months from the date the advance is made. The interest rate is the 30-day commercial paper rate available for similar amounts on commercial paper borrowings by ENSERCH. Interest is payable monthly. These arrangements are renewed annually. At December 31, 1993, there were $27,216 of net short-term borrowings outstanding under these arrangements at an interest rate of 3.28%.\nLong-term Notes Payable - Long-term notes payable to Processing are summarized below:\nInterest on the above notes is payable semiannually on June 30 and December 31. The estimated fair value of these notes was $352 million at December 31, 1993 and $300 million at December 31, 1992. The calculation was made using a discounted cash flow approach based on the interest rates currently available to ENSERCH for debt with similar terms and remaining maturities.\n4. RELATED PARTY TRANSACTIONS\nIn the ordinary course of business, EP engages in various transactions with ENSERCH and its affiliates. All such transactions are subject to review by the Policy and Conflicts of Interest Committee of ENSERCH, a committee composed solely of outside directors. The Committee has found no unfair dealings between and among such parties. EP is charged for direct costs incurred by ENSERCH and EEI that are associated with managing EP's business and operations. Additionally, indirect costs (principally general and\nA-16\nadministrative costs) applicable to EP are allocated to EP by ENSERCH. Such charges amounted to $2,026, $1,927 and $1,798 in 1993, 1992 and 1991, respectively.\nEP had sales to affiliated companies (Enserch Gas Company, Lone Star Gas Company and Processing) of $108,916, $32,508 and $32,710 in 1993, 1992 and 1991, respectively. In 1993, affiliated revenues include gas sales of $91,000 under new contracts effective March 1, 1993 with Enserch Gas Company covering essentially all gas production not committed under existing contracts.\nNet interest costs incurred on affiliated borrowings were $27,120, $25,336, and $22,872 in 1993, 1992 and 1991, respectively.\n5. COMMITMENTS AND CONTINGENT LIABILITIES\nAdvances Under Leasing Arrangements - In May 1992, EP entered into an operating leasing arrangement to provide financing for its portion of the offshore platform and related facilities for the 37 1/2% owned Mississippi Canyon Block 441 project. A total of $34 million was required for the project, which was completed in early 1993. EP leased the facilities for an initial period through May 20, 1994, with an option to renew the lease, with the consent of the lessor, for up to 10 successive six-month periods. The lease has been renewed through November 20, 1994 and EP expects to renew the lease for all renewal periods. EP has the option to purchase the facilities throughout the lease periods and as of December 31, 1993, has guaranteed an estimated residual value for the facilities of approximately $27 million should the lease not be renewed. Expenses incurred under the lease in 1993 was $2.1 million. The estimated future minimum net rentals for the Mississippi Canyon operating lease is $6.3 million for 1994.\nIn September 1992, EP entered into an operating lease arrangement to provide financing for the offshore platform and related facilities of its 100% owned Garden Banks Block 388 project. The lessor will fund the construction cost of the facilities quarterly, up to a maximum of $235 million. As of December 31, 1993, a total of $60 million had been advanced to EP under the lease as agent for the lessor, $31 million of which was unexpended and reflected as a current liability. EP will lease the facilities for an initial period through March 31, 1997, with the option to renew the lease, with the consent of the lessor, for up to three successive two-year periods. EP, as agent for the lessors, will acquire, construct and operate the units of leased property and has guaranteed completion of construction of the facilities. EP has the option to purchase the facilities throughout the lease periods and has guaranteed an estimated residual value for the facilities of approximately $188 million, assuming the full lease amounts are advanced and expended, should the lease not be renewed. The estimated future minimum net rentals for the Garden Banks operating lease are as follows: $4.8 million for 1994; $9.1 million for 1995; $9.1 million for 1996; and $2.3 million for 1997. Lease payments are being deferred during the construction period and will be amortized when production begins.\nA-17\nAt December 31, 1993, EEI had several noncancelable operating leases, principally for buildings and office space, that expire at various dates through 1998. EP bears an allocated share of rental expenses incurred by EEI under noncancelable operating leases. EP's allocated share of rental expenses (99% of EEI's rental expenses) totaled $4,985, $3,547 and $2,938 in 1993, 1992 and 1991, respectively. Future minimum rentals under such leases, of which EP would bear its proportionate share, are as follows: $1.3 million for 1994; $1.3 million for 1995; $1.4 million for 1996; $1.5 million for 1997; and $1.4 million for 1998.\nLegal Proceedings - A lawsuit was filed against EEI, ENSERCH, its utility division and EPO in the 348th Judicial District Court of Tarrant County in May 1989. Plaintiffs seek unspecified actual damages and punitive damages in the amount of $5 million. Plaintiffs allege royalties were not fully paid, certain expenses were improperly charged against the amount of royalties due, negligence in the venting of gas and liquid hydrocarbons into the air, and breach of duty of good faith and fair dealing by wrongfully concealing certain material facts concerning sales of gas from the subject leases to the utility division.\nA lawsuit was filed on February 24, 1987, in the 112th Judicial District of Sutton County, Texas, against subsidiaries and affiliates of ENSERCH, as well as its utility division. The plaintiffs have claimed that defendants failed to make certain production and minimum purchase payments under a gas- purchase contract. In this connection, the plaintiffs have alleged a conspiracy to violate purchase obligations, improper accounting of amounts due, fraud, misrepresentation, duress, failure to properly market gas and failure to act in good faith. In this case, plaintiffs seek actual damages in excess of $5 million and punitive damages in an amount equal to 0.5% of the consolidated gross revenues of ENSERCH for the years 1982 through 1986 (approximately $85 million), interest, costs and attorneys' fees.\nOn December 26, 1989, a lawsuit was filed against EEI and EPO in the 130th Judicial District Court of Matagorda County, Texas. The plaintiff claims that the defendants breached an alledged contract to sell a working interest and net revenue interest in two leases located in Matagorda County. Trial of the case resulted in a jury verdict in favor of the plaintiff. Judgment was entered by the trial court on October 8, 1992, ordering EEI and EPO to convey the leases to the plaintiff and to pay damages of $3.1 million, which includes principal, prejudgment interest, attorneys' fees and costs. This judgment was appealed to the Corpus Christi Court of Appeals on September 2, 1992. Counsel has advised that there is a reasonable basis to believe that the decision of the trial court will be reversed.\nOn October 25, 1991, a lawsuit was filed against EEI, EPO and ENSERCH in the 111th District Court of Webb County Texas. Other parties have intervened. The plaintiffs and intervenors claim that the defendants' failure to reassign\nA-18\npart of an gas and oil lease covering approximately 33,000 net mineral acres in breach of defendants' contractual reassignment obligations entitles them to recover the fair market value of the lost leasehold estate and lost overriding royalty interests. Plaintiffs and intervenors claim actual damages of approximately $3.1 million for the lost leasehold estate, and approximately $2.2 million for the lost overriding royalty interests. They also seek pre- judgment interest, attorney's fees and costs.\nManagement believes that the named defendants have meritorious defenses to the claims made in these and other actions. In the opinion of management, EP will incur no liability from these and all other pending claims and suits that would be considered material for financial reporting purposes.\n6. SUPPLEMENTAL FINANCIAL INFORMATION\nQuarterly Results (Unaudited) - The results of operations by quarters are summarized below. In the opinion of EP's management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation have been made.\nDecrease (Increase) in Current Operating Assets and Liabilities by Components - is summarized below:\nA-19\nInterest Costs - are summarized below:\n7. SUPPLEMENTAL GAS AND OIL INFORMATION\nGas and Oil Producing Activities - The following tables set forth information relating to gas and oil producing activities. Reserve data for natural gas liquids attributable to leasehold interests owned by EP are included in oil and condensate.\nA-20\nExcluded Costs - The following table sets forth the composition of capitalized costs excluded from the amortizable base as of December 31, 1993:\nAt December 31, 1993, approximately 43% of excluded costs relates to offshore activities in the Gulf of Mexico and the remainder relates to domestic onshore exploration activities. The anticipated timing of the inclusion of these costs in the amortization computation will be determined by the rate at which exploratory and development activities continue, which is expected to be accomplished within ten years.\nGas and Oil Reserves (Unaudited) - The following table of estimated proved and proved developed reserves of gas and oil has been prepared utilizing estimates of yearend reserve quantities provided by DeGolyer and MacNaughton, independent petroleum consultants. Reserve estimates are inherently imprecise and estimates of new discoveries are more imprecise than those of producing gas and oil properties. Accordingly, the reserve estimates are expected to change as additional performance data becomes available. Oil reserves (which include condensate and natural gas liquids attributable to leasehold interests) are stated in thousands of barrels (MBbl). Gas reserves are stated in million cubic feet (MMcf). All reserves are located in the United States.\nA-21\nIncluded in oil reserve estimates are natural gas liquids for leaseold interest of 931 MBbl for 1993; 789 MBbl for 1992; and 743 MBbl for 1991.\nA-22\nResults of Operations for Producing Activities (excluding corporate overhead and interest costs) - are as follows:\nStandardized Measure of Discounted Future Net Cash Flows Relating to Proved Gas and Oil Reserve Quantities (Unaudited) - has been prepared by EP using estimated future production rates and associated production and development costs. Continuation of economic conditions existing at the balance sheet date was assumed. Accordingly, estimated future net cash flows were computed by: applying prices in contracts in effect in December to estimated future production of proved gas and oil reserves; estimating future expend- itures to develop proved reserves; and estimating costs to produce the proved reserves based on average costs for the year. Average prices used in the computations were:\nBecause of the imprecise nature of reserve estimates and the unpredictable nature of other variables used, the standardized measure should be interpreted as indicative of the order of magnitude only and not as precise amounts.\nA-23\nThe following table sets forth an analysis of changes in the standardized measure of discounted future net cash flows from proved gas and oil reserves:\nA-24\nENSERCH EXPLORATION PARTNERS, LTD. DEPOSITARY UNIT MARKET PRICES AND DISTRIBUTION INFORMATION\nMarket Prices\nEP's Depositary Units evidenced by Depositary Receipts are traded on the New York Stock Exchange. The following table shows the high and low sales prices per unit reported in the New York Stock Exchange - Composite Transactions report for the periods shown, as quoted in The Wall Street Journal.\nDepositary Unit Data\nDistributions Per Unit\nIn February 1994, the Board of Directors of EEI, managing general partner of EP, announced that the quarterly cash distributions to unitholders had been indefinitely suspended. Reinstatement of a cash distribution will depend on a number of considerations, including future cash flows and capital spending requirements. The following table shows the distributions per limited partnership unit paid by EP during 1993, 1992 and 1991.\nA-25\nAPPENDIX B\nENSERCH EXPLORATION PARTNERS, LTD. INDEX TO FINANCIAL STATEMENT SCHEDULES December 31, 1993\nPage\nIndependent Auditors' Report . . . . . . . . . . B-2\nFinancial Statement Schedules for Each of the Three Years in the Period Ended December 31, 1993:\nIV - Indebtedness to Related Parties. . . . B-3\nV - Property, Plant and Equipment. . . . . B-4\nVI - Accumulated Depreciation and Amortization of Property, Plant and Equipment. . . . . . . . . . B-5\nX - Supplementary Statements of Operations Information. . . . . . . . . . . . . . B-6\nB-1\nINDEPENDENT AUDITORS' REPORT\nTo the Partners of Enserch Exploration Partners, Ltd.:\nWe have audited the financial statements of Enserch Exploration Partners, Ltd. as of December 31, 1993 and 1992, and for each of the three years in the period ended December 31, 1993, and have issued our report thereon dated February 7, 1994; such report is included elsewhere in this Form 10-K. Our audits also included the financial statement schedules of Enserch Exploration Partners, Ltd. listed in Item 14. These financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDELOITTE & TOUCHE\nDallas, Texas February 7, 1994\nB-2"},"word_count":{"kind":"number","value":9931,"string":"9,931"},"character_count":{"kind":"number","value":62095,"string":"62,095"}}},{"rowIdx":289,"cells":{"filename":{"kind":"string","value":"201533_1993.txt"},"id":{"kind":"string","value":"201533_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"201533"},"text":{"kind":"string","value":"ITEM 1. BUSINESS.\nGENERAL\nCMS Energy\nCMS Energy, incorporated in Michigan in 1987, is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the largest subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to end- users, and 4) transmission and storage of natural gas. For further information about subsidiary operations, see Item 1. BUSINESS. SUBSIDIARIES. CMS Energy is exempt from registration under PUHCA, see Item 1. BUSINESS. CMS ENERGY AND CONSUMERS REGULATION.\nCMS Energy's consolidated operating revenue in 1993 was derived approximately 61 percent from sales of electric energy, approximately 37 percent from sale, transportation and storage of natural gas, and approximately 2 percent from oil and gas exploration and production activities. Consumers' consolidated operations in the electric and gas businesses account for the major share of CMS Energy's total assets, revenue and income. CMS Energy's share of unconsolidated non-utility electric generation and gas transmission revenue for 1993 was $337 million.\nConsumers\nConsumers was incorporated in Michigan in 1968 and is the successor to a corporation of the same name which was organized in Maine in 1910 and which did business in Michigan from 1915 to 1968.\nConsumers is a public utility serving almost 6 million of Michigan's 9 million residents in 67 of the 68 counties in Michigan's Lower Peninsula. Industries in Consumers' service area include automotive, metal, chemical, food and wood products and a diversified group of other industries. Consumers' consolidated operating revenue in 1993 was derived approximately 64 percent from its electric business and approximately 36 percent from its gas business. Consumers' retail rates and certain other aspects of its business are subject to the jurisdiction of the MPSC. Consumers has five direct subsidiaries. For further information about subsidiary operations, see Item 1. BUSINESS. SUBSIDIARIES.\nBUSINESS SEGMENTS\nCMS Energy conducts its principal operations through the following five business segments: electric utility operations; gas utility operations; oil and gas exploration and production operations; independent power production; and gas transmission and marketing. Consumers or subsidiaries of Consumers are engaged in two segments: electric operations and gas operations. Consumers' electric and gas businesses are regulated utility operations.\nConsumers Electric Utility Operations Consumers generates, purchases, transmits and distributes electricity and renders electric service in 61 of the 68 counties in the Lower Peninsula of Michigan. Prin- cipal cities served include Battle Creek, Flint, Grand Rapids, Jackson, Kalamazoo, Muskegon, Saginaw and Wyoming.\nConsumers Gas Utility Operations Consumers purchases, transports, stores, and distributes gas and renders gas service in 40 of the 68 counties in the Lower Peninsula of Michigan. Principal cities served include Bay City, Flint, Jackson, Kalamazoo, Lansing, Pontiac and Saginaw, as well as the suburban Detroit area. Consumers' wholly owned subsidiary, Michigan Gas Storage, is engaged in the transportation and storage of natural gas in interstate commerce.\nCMS Enterprises CMS Generation Independent Power Production CMS Generation, a wholly owned subsidiary of Enterprises, invests in, develops, converts and/or constructs and operates non-utility power generation plants both domestically and internationally. CMS Generation currently has ownership in- terests in power plants in Michigan, Cali- fornia, Connecticut, New York and Argentina.\nCMS Enterprises NOMECO Oil and Gas Exploration and Production NOMECO, a wholly owned subsidiary of Enterprises, and subsidiaries of NOMECO are engaged in the exploration for and production of oil and natural gas in Michigan and 12 other states, the Gulf of Mexico, Australia, Colombia, Ecuador, Equatorial Guinea, New Zealand, Papua New Guinea, Thailand and Yemen. NOMECO has 11 active wholly owned subsidiaries which are engaged in the exploration, development and operation of oil and gas interests and rights.\nCMS Enterprises Gas Transmission and Storage Enterprises has two subsidiaries which participate in non-utility natural gas businesses, including transportation, treating, storage and marketing.\nFINANCIAL INFORMATION\nCMS Energy\nFor information with respect to operating revenue, net operating income (loss) and assets and liabilities attributable to all of CMS Energy's business segments, refer to its Consolidated Financial Statements and to the Notes to Consolidated Financial Statements for the year ended December 31, 1993, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is incorporated herein by reference.\nConsumers\nFor information with respect to the operating revenue, net operating income (loss) and assets and liabilities attributable only to Consumers' business segments, refer to its Consolidated Financial Statements and to the Notes to Consolidated Financial Statements for the year ended Decem- ber 31, 1993, in Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, which is incorporated herein by reference.\nEMPLOYEES\nCMS Energy\nAs of February 28, 1994, CMS Energy and its subsidiaries had 9,874 full- time employees and 294 part-time employees for a total of 10,168 employees.\nConsumers\nAs of February 28, 1994, Consumers and its subsidiaries had 9,434 full- time employees and 277 part-time employees for a total of 9,711 employees. This total includes 4,212 full-time operating, maintenance and construction employees of Consumers who are represented by the Union. A new collective bargaining agreement was negotiated between Consumers and the Union which became effective on June 1, 1992 and, by its terms, will continue in full force and effect until June 1, 1995.\nSIGNIFICANT DEVELOPMENTS CONCERNING MCV COST RECOVERY ISSUES\nThe MCV Partnership was formed in January 1987 by subsidiaries of Consumers and Dow to convert a portion of Consumers' abandoned Midland Nuclear Plant into a natural gas-fueled, combined cycle cogeneration facility. The MCV Facility has been certified as a Qualifying Facility under PURPA. CMS Energy, certain other affiliates and the other partners in the MCV Partnership made certain contingent undertakings related to the MCV Partnership's sale and leaseback transaction. These included, but were not limited to, indemnifications related to tax matters and a commitment to extend a $10 million standby working capital facility to the MCV Partnership. In addition, CMS Energy and certain of its affiliates undertook certain indemnifications related to environmental matters regarding the site. Consumers' current interests in the MCV Partnership and the MCV Facility are discussed more fully in Note 3 of the Notes to Consolidated Financial Statements.\nIn 1987, Consumers signed a PPA with the MCV Partnership for the purchase of up to 1,240 megawatts of capacity for a 35-year period beginning with the MCV Facility's commercial operation in March 1990. Consumers' cost recovery from its electric customers for the amount of capacity purchased by Consumers from the MCV Partnership, the price paid by Consumers for that capacity and associated energy, and the method of rate recovery for those purchases had been at issue before the MPSC and the Michigan appellate courts since Consumers' first attempt to recover those costs in its annual power supply cost recovery proceedings. Because the MPSC consistently denied Consumers full recovery of the costs it incurred for its purchases from the MCV Partnership, Consumers incurred significant ongoing annual losses. On March 31, 1993, the MPSC issued an Opinion and Order on a Revised Settlement Proposal, which had been submitted by Consumers, CMS Energy, the MPSC Staff, and ten qualifying facility developers, approving it with certain modifications. For a discussion of the Revised Settlement Proposal as approved by the MPSC's March 31, 1993 Order, see Note 3 of the Notes to Consolidated Financial Statements, which is incorporated by reference herein. With Consumers' acceptance of the MPSC's decision on the Revised Settlement Proposal, the uncertainties surrounding Consumers' cost recoveries related to its purchases from the MCV Partnership were resolved to a sufficient degree that Consumers effected a quasi-reorganization as of December 31, 1992 in which Consumers' accumulated deficit was eliminated against other paid-in capital. Following this quasi-reorganization Consumers resumed paying dividends in 1993. The quasi-reorganization is more fully described in Note 7 of the Notes to Consolidated Financial Statements.\nA dispute has arisen between the MCV Partnership and Consumers relating to the impact of the order on the fixed energy charge payment, currently approx- imately 7 percent of the charges for capacity and energy, called for in the PPA and Consumers' ability to exercise its rights under the regulatory out provision based on the issuance of the Settlement Order. In accordance with the dispute resolution provisions set out in the PPA, an arbitrator acceptable to both parties has been selected and the arbitration of this dispute has commenced. Consumers is unable to predict the outcome of such arbitration proceedings or of any possible settlement of the issues underlying this dispute. On March 4, 1994, the lessors of the MCV Facility filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of the arbitration between the MCV Partnership and Consumers. While CMS Energy and Consumers believe this lawsuit to be without merit, they are unable to predict the outcome of this action. For a discussion of the arbitration proceedings and the lawsuit filed by the lessors, see Note 3 of the Notes to Consolidated Financial Statements and Item 3. LEGAL PROCEEDINGS, which are incorporated by reference herein.\nCONSUMERS ELECTRIC UTILITY OPERATIONS\nConsumers had approximately 1.5 million electric customers at December 31, 1993. Electric system energy sales by Consumers in 1993 totaled 31.66 billion kWh, a 3.8 percent increase from 1992. Electric operating revenue in 1993 was $2.077 billion, an increase of 11.5 percent from 1992. A peak demand of 6,226 MW was achieved in August 1993, representing an increase of 4.8 percent from the peak achieved in 1992 predominantly as a result of warmer than normal weather and improved industrial sales. Consumers' reserve margin was approximately 21 percent in 1993 and 19 percent in 1992, based on weather adjusted peaks.\nIncluding the Ludington pumped storage facility, in which it has a 51 percent ownership and capacity entitlement, Consumers owns and operates 28 electric generating plants with an aggregate net demonstrated capability available to Consumers, as of 1993 for summer conditions, of 6,299 MW. See Item 2.\n\n\nITEM 2. PROPERTIES.\nCHARACTER OF OWNERSHIP\nThe principal properties of CMS Energy and its subsidiaries are owned in fee, except that most electric lines and gas mains are located, pursuant to ease- ments and other rights, in public roads or on land owned by others. The statements under this item as to ownership of properties are made without regard to tax and assessment liens, judgments, easements, rights of way, contracts, reservations, exceptions, conditions, immaterial liens and encum- brances, and other outstanding rights. None of these outstanding rights impairs the usefulness of such properties.\nSubstantially all of Consumers' properties are subject to the lien of its First Mortgage Bond Indenture.\nCONSUMERS ELECTRIC UTILITY PROPERTIES\nConsumers' electric generating system consists of five fossil-fueled plants, two nuclear plants, one pumped storage hydroelectric facility, seven gas combustion turbine plants and 13 hydroelectric plants.\nConsumers' electric transmission and distribution lines owned and in service are as follows:\nStructure Sub-Surface (Miles) (Miles)\nTransmission 345,000 volt 1,137 - 138,000 volt 3,246 4 120,000 volt 19 - 46,000 volt 4,066 9 23,000 volt 31 7 ------ ----- Total transmission 8,499 20\nDistribution (2,400-24,900 volt) 50,359 4,756 ------ ----- Total transmission and distribution 58,858 4,776 ====== ===== Consumers owns substations having an aggregate transformer capacity of 36,249,290 kilovoltamperes.\nCONSUMERS GAS UTILITY PROPERTIES\nConsumers' gas distribution and transmission system consists of 20,768 miles of distribution mains and 1,084 miles of transmission lines throughout the Lower Peninsula of Michigan. Consumers owns and operates five compressor stations with a total of 116,070 installed horsepower.\nConsumers' gas storage fields, listed below, have an aggregate certified storage capacity of 241.5 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nOverisel Allegan and Ottawa Counties 64.0 Salem Allegan and Ottawa Counties 35.0 Ira St Clair County 7.5 Lenox Macomb County 3.5 Ray Macomb County 66.0 Northville Oakland, Washtenaw and Wayne Counties 25.8 Puttygut St Clair County 16.6 Four Corners St Clair County 3.8 Swan Creek St Clair County .6 Hessen St Clair County 18.0 Lyon - 34 Oakland County .7\nMichigan Gas Storage owns and operates two compressor stations with a total of 46,600 installed horsepower. Its transmission system consists of 547 miles of pipelines within the Lower Peninsula of Michigan.\nMichigan Gas Storage's gas storage fields, listed below, have an aggregate certified storage capacity of 117 bcf:\nTotal Certified Field Name Location Storage Capacity (bcf)\nWinterfield Osceola and Clare Counties 75.0 Cranberry Lake Clare and Missaukee Counties 30.0 Riverside Missaukee County 12.0\nConsumers' gas properties also include the Marysville gas reforming plant, located in Marysville, Michigan. Huron entered into a partnership with PanCanadian Petroleum Company and CanStates Investments to use the expanded capacity of the underground caverns at the Marysville plant for commercial storage of liquid hydrocarbons. On February 1, 1994 PanCanadian Petroleum Company purchased CanStates Investments. In addition, Consumers and Novacor Hydrocarbons, Inc. are partners in a partnership to use certain hydrocarbon fractionation facilities at the plant.\nCMS ENERGY OIL AND GAS EXPLORATION AND PRODUCTION PROPERTIES\nNOMECO has carried on a domestic oil and gas exploration program since 1967. In 1976, NOMECO entered its first venture outside the United States.\nNet oil and gas production by NOMECO for the years 1991 through 1993 is shown in the following table.\nThousands of barrels of oil and millions of cubic feet of gas, except for reserves\n1993 1992 1991\nNatural gas (a) 18,487 17,578 14,714 Oil and condensate (a) 1,716 1,417 1,260 Plant products (a) 186 291 283 Average daily production (b) Oil 5.6 4.9 4.1 Gas 62.3 59.2 50.5\nReserves to annual production ratio Oil (MMbbls) 19.1 22.6 21.9 Gas (bcf) 10.9 11.8 13.0\n(a) Revenue interest to NOMECO (b) NOMECO working interest (includes NOMECO's share of royalties)\nThe following table shows NOMECO's undeveloped net acres of oil and gas leasehold interests at December 31.\nNet Acres 1993 1992\nMichigan 77,672 120,740 Louisiana (a) 37,295 39,226 Texas (a) 8,083 10,411 North Dakota 5,635 - Indiana 5,034 715 Other states 2,184 2,581 ------- --------- Total domestic 135,903 173,673 ------- --------- Thailand 188,000 188,000 Yemen 120,563 - Papua New Guinea 96,825 63,220 Equatorial Guinea 83,334 83,334 Ecuador 69,160 69,160 New Zealand 602 1,544 China (b) - 589,334 ------- --------- Total international 558,484 994,592 ------- --------- Total 694,387 1,168,265 ======= ========= (a) Includes offshore acreage.\n(b) Acreage excluded at year-end 1993 as part of an agreement with the state oil company to discontinue its current exploration program because it has been unsuccessful.\nCONSUMERS OTHER PROPERTIES\nCMS Midland owns a 49 percent interest in the MCV Partnership which was formed to construct and operate the MCV Facility. The MCV Facility has been sold to five owner trusts and leased back to the MCV Partnership. CMS Holdings is a limited partner in the FMLP, which is a beneficiary of one of these trusts. CMS Holdings' indirect beneficial interest in the MCV Facility is 35 percent.\nConsumers owns fee title to 1,140 acres of land in the City and Township of Midland, Midland County, Michigan, occupied by the MCV Facility. The land is leased to the owners of the MCV Facility by five separate leases, each leasing an undivided interest and in the aggregate totaling 100 percent, for an initial term ending December 31, 2035 with possible renewal terms to June 15, 2090.\nConsumers owns or leases three principal General Office buildings in Jackson, Michigan and 53 Regional and other field offices at various locations in Michigan's Lower Peninsula. Of these, two of the General Office buildings and eleven of the Regional and other field offices are leased. Also owned are miscellaneous parcels of real estate not now used in utility operations.\nCMS ENERGY OTHER PROPERTIES\nVarious subsidiaries of CMS Generation own interests in independent power plants, including a 50 percent partnership interest in a 30 MW wood waste- fueled power plant near Susanville, California; a 50 percent partnership interest in a 54 MW coal and wood waste-fueled power plant in Filer City, Michigan; a 50 percent partnership interest in a 34 MW wood waste-fueled power plant in Grayling Township, Michigan; a 50 percent interest in a 26 MW tire burning power plant near Sterling, Connecticut; a 50 percent interest in a wood waste-fueled power plant in Lyons Falls, New York; an 18.6 percent interest in a consortium which owns an 88 percent interest in a 50 MW fossil-fueled plant in San Nicolas, Argentina; a 25 percent interest in a consortium which owns a 59 percent interest in two hydroelectric power plants, with a total of 1,320 MW of capacity, on the Limay River in western Argentina; and a 50 percent ownership interest in a 18 MW wood waste-fueled power plant near Chateaugay, New York.\nCMS Gas Transmission owns a 75 percent interest in a general partnership which owns and operates a 25-mile, 16-inch natural gas transmission pipeline in Jackson and Ingham Counties, Michigan; owns a 24 percent limited partnership interest in the Saginaw Bay Area Limited Partnership which owns 125 miles of 10-inch and 16-inch natural gas transmission pipeline in north-central Michigan; owns a 44 percent limited partnership interest in a partnership that owns certain pipelines of 20 and 12 miles interconnected to the Saginaw Bay Area Limited Partnership facilities; owns a 60 percent interest in a partnership that owns and operates a natural gas treating plant in Otsego County, Michigan; and owns 100 percent interest in 41 miles of gas transmission pipeline in Otsego and Montmorency Counties, Michigan.\nCMS Energy, through certain subsidiaries owns approximately 6,000 acres of undeveloped land in Benzie and Manistee Counties, Michigan, approximately 53 acres of undeveloped land in Muskegon County, Michigan, and approximately 300 acres in undeveloped land in Emmet County, Michigan.\nCONSUMERS CAPITAL EXPENDITURES\nCapital expenditures during 1993 for Consumers and its subsidiaries totaled $509 million for capital additions and $52 million for demand-side management programs. These capital additions include approximately $31 million for environmental protection additions. Of the $509 million, $265 million was incurred for electric utility additions, $126 million for gas utility additions, $58 million for capital leases (see Note 14 to Consumers' Consolidated Financial Statements incorporated by reference herein), and $60 million for other additions and capital investments.\nIn 1994, capital expenditures are estimated to be $513 million for capital additions and $40 million for demand-side management programs. These capital addition estimates include approximately $48 million related to environmental protection additions. Of the $513 million, $290 million will be incurred for electric utility additions, $98 million for gas utility additions, $73 million for capital leases, and $52 million for other additions and capital investments.\nCMS ENERGY CAPITAL EXPENDITURES\nCapital expenditures during 1993 for CMS Energy and its subsidiaries totaled $714 million for capital additions and $52 million for demand-side management programs. These capital additions include approximately $31 million for environmental protection additions. Of the $714 million, $509 million was incurred by Consumers as discussed above. The remaining $205 million in capital additions include $81 million for oil and gas exploration, $110 million for independent power production and $14 million for gas transmission and marketing.\nIn 1994, capital expenditures are estimated to be $752 million for capital additions and $40 million for demand-side management programs. This capital addition estimate includes approximately $48 million related to environmental protection additions. Of the $752 million, $513 million will be incurred by Consumers as discussed above. The remaining $239 million in capital additions will be incurred as follows: $117 million for oil and gas exploration, $84 million for independent power production and $38 million for gas transmission and marketing.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\nConsumers and some of its subsidiaries and affiliates are parties to certain routine lawsuits and administrative proceedings incidental to their businesses involving, for example, claims for personal injury and property damage, contractual matters, income taxes, and rates and licensing. Reference is made to the Notes to the Consolidated Financial Statements included herein for additional information regarding various pending administrative and judicial proceedings involving rate, operating and environmental matters.\nThe Attorney General, ABATE, and the MPSC Staff typically intervene in MPSC proceedings concerning Consumers. Unless otherwise noted below, these parties have intervened in such proceedings. For many years, almost every significant MPSC order affecting Consumers has been appealed. Appeals from such MPSC orders are pending in the Michigan Court of Appeals and the Michigan Supreme Court. Consumers is vigorously pursuing these matters. Under Michigan civil procedure, parties may file a claim of appeal with the Michigan Court of Appeals which serves as a notice of appeal. The grounds on which the appeal is being made are not set forth until a later date when the parties file their briefs.\n1. Electric Rate Case Proceedings\nA. Appeal of MPSC Orders Related to the Abandoned Midland Nuclear Plant Investment\nIn November 1983, Consumers filed an electric rate case with the MPSC which sought recovery of its investment in the abandoned portion of the Midland nuclear plant. This case was separated into two phases in September 1984: a financial stabilization phase, MPSC Case No. U-7830, Step 3A, and a prudence phase, MPSC Case No. U-7830, Step 3B. Numerous orders were issued in these cases, including one issued in 1985 in the financial stabilization phase which contained certain conditions to Consumers' receiving financial stabilization rate relief.\nOn May 7, 1991, the MPSC issued final orders in both Step 3A and Step 3B proceedings in which, among other things, the MPSC ruled that Consumers could recover approximately $760 million of the $2.1 billion of abandoned Midland investment. Consumers, as well as the Attorney General and ABATE, among others, filed applications for rehearing with the MPSC of the May 7 Orders in Step 3A and Step 3B. which were all denied by the MPSC. Several parties, including Consumers, have appealed the MPSC determinations in these orders to the Court of Appeals. The Attorney General and ABATE primarily disagree with the standard used by the MPSC to determine the amount of investment that is recoverable by Consumers from its electric customers, contending that recovery should not be allowed for utility assets that have not been placed in service. Consumers disagrees with the date the MPSC determined it would have been prudent for Consumers to abandon construction of the Midland nuclear facility and the reduction in recoverable investment that resulted from this determination. All briefs have been filed in these appeals. Oral argument has not yet been scheduled on the Step 3B appeals; oral argument was held on the Step 3A appeal in December 1993.\nB. Appeal of 1991 General Electric Rate Case Order\nOn May 7, 1991, the MPSC issued an order in Case No. U-9346, a general electric rate case the MPSC ordered Consumers to file in response to a complaint filed by ABATE. On July 1, 1991, the MPSC issued another order in this proceeding modifying the May 7 Order. These orders, together with the other orders discussed in paragraph A above, reduced Consumers' electric retail rates by an annual amount of approximately $73 million.\nCertain aspects of the May 7, 1991 and July 1, 1991 electric rate case orders were appealed by the Attorney General, ABATE, and the Michigan Association of Home Builders. The appeals of the Attorney General and the Michigan Association of Home Builders have both been dismissed. ABATE's appeal, which primarily seeks a reduction in the rates authorized by the MPSC, remains pending. Briefs have been filed in the ABATE appeal and oral argument was held in December 1993.\nC. 1993 Electric Rate Case\nOn May 10, 1993, Consumers filed an application with the MPSC seeking an increase in its base electric rates (MPSC Case No. U-10335). As a result of the new statutory federal tax rate and interest rate savings resulting from the refinancing of certain long-term debt, Consumers subsequently revised its requested electric rate increase to approximately $133 million in 1994 while its requested electric rate increase for 1995 remained at $38 million. In their initial brief, the MPSC Staff recommended approximately $98 million in annual rate relief beginning in 1994. The MPSC Staff also recommended a lower return on electric common equity (11.75 percent compared with Consumers' proposal of 13.25 percent), and using a projected actual equity ratio in the projected capitalization structure rather than a target ratio. The MPSC Staff did not support Consumers' request for additional rate relief for 1995 as part of this proceeding, but did support Consumers' rate design proposal to significantly reduce the level of cross-subsidization of residential customers' rates by commercial and industrial customers.\nA PFD was issued in this case on March 4, 1994. In the PFD the ALJ recommended a rate increase in 1994 of approximately $83 million with no incremental increase in 1995 to be granted as part of this proceeding. The ALJ adopted MPSC Staff's recommendation of an 11.75 percent return on common equity and the use of 1994 projected actual capital structure rather than the target structure proposed by Consumers. The PFD rejected a proposal made by Consumers through which returns above the authorized level would be shared with customers, but recommended the implementation of a performance incentive proposal Consumers had initially proposed with some modifications. The PFD also recommended the adoption of the cross- subsidization reduction proposed by Consumers modified so that subsidization would be immediately reduced by 50 percent in 1994 rates rather than the phased-in 20 percent per year over a three year period reduction proposed by Consumers.\nExceptions to the PFD are due March 18 with replies to exceptions due April 1. The PFD is not binding on the MPSC. An order of the MPSC will be issued sometime thereafter.\nD. 1986 Proceedings - Palisades Outages\nThe Palisades nuclear plant was out of service for maintenance from May 1986 until April 1987. In the 1986 PSCR reconciliation case decided December 22, 1988, the MPSC disallowed recovery of $22.4 million of replacement power costs associated with the 1986 portion of this outage and refunds to the customers were made. In an appeal filed in 1989 and now pending decision by the Court of Appeals, Consumers is challenging the adequacy of the MPSC's findings supporting the disallowance. Oral arguments were held in December 1993 and in March 1994 the Court of Appeals affirmed the MPSC order in a per curiam opinion.\n2. Settlement Proposals Relating to Consumers' Purchases from the MCV Partnership\nOn March 31, 1993, the MPSC issued the Settlement Order which approved with modifications the Revised Settlement Proposal filed by Consumers, the MPSC Staff and 10 small power and cogeneration developers. The scope of the Settlement Order included three major components: 1) treatment of cost recovery issues regarding the PPA, 2) resolution of PURPA issues raised by certain developers of Qualifying Facilities that had wanted contracts with Consumers, and 3) resolution of the remand to the MPSC ordered by the Court of Appeals in the Capacity Charge Order. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. On May 26, 1993, the MPSC denied petitions filed by the Attorney General, ABATE, MMCG and a small project developer which requested a rehearing of the Settlement Order by the MPSC. ABATE and the Attorney General have filed claims of appeal of the Settlement Order and the May 26, 1993 MPSC order with the Court of Appeals. Briefs have been filed with the Court of Appeals on this matter but oral argument has not yet been scheduled. In their respective briefs in opposition to the Settlement Order, ABATE and the Attorney General essentially reiterate the arguments they made before the MPSC in their petitions for rehearing. The substance of ABATE's and the Attorney General's arguments is that the MPSC exceeded its authority in approving the Revised Settlement Proposal as modified by the Settlement Order and the rates established thereby are not just and reasonable and lack evidentiary support. ABATE and the Attorney General also contend that the MPSC's procedures for the hearing on the Revised Settlement Order violated due process and denied ABATE and the Attorney General a fair hearing. In defense of the Settlement Order, the Independent Cogenerators, Consumers and the MPSC argue in their respective briefs to the Court of Appeals that the determinations of the MPSC in the Settlement Order are lawful and reasonable and that the Attorney General and ABATE have failed to meet the statutory burden of proof minimally necessary for the Court of Appeals to find otherwise.\nIn accordance with the terms of the Settlement Order, appeals of MPSC orders relating to MCV cost recovery issues in Consumers' 1990, 1991 and 1992 PSCR cases that had been pending before the Court of Appeals and the Michigan Supreme Court have been withdrawn.\n3. MPSC Case No. U-10029 - Intrastate Gas Supply\nIn November 1991, Consumers filed with the MPSC Case No. U-10029 seeking several kinds of relief with respect to a contract with one of Consumers' intrastate gas suppliers, North Michigan, including lowering a contract price. North Michigan filed an objection with the MPSC and in July 1992 filed a collateral case in Federal Court seeking an injunction to block the MPSC case. On April 8, 1993, the Federal Court dismissed Northern Michigan's suit. An appeal of the Federal Court's decision is pending in the U.S. Sixth Circuit Court of Appeals.\nOn February 8, 1993, the MPSC issued an order granting Consumers' request to lower the price to be paid North Michigan under its contract. In March 1993, North Michigan filed an appeal of the MPSC's February 8, 1993 order with the Court of Appeals. In July 1993, consistent with the MPSC's February 8, 1993 Order, Consumers notified North Michigan that it planned to terminate the contract in November 1993. In early October 1993, North Michigan sought to have the Court of Appeals stay Consumers' cancellation of the contract. The Court of Appeals denied this request in late October 1993 and Consumers terminated its contract with North Michigan effective November 1, 1993. If the MPSC order is overturned, Consumers would have to pay North Michigan higher contract costs for purchases in 1993 which may not be authorized by the MPSC for recovery from Consumers' customers. Should North Michigan obtain a favorable decision on all of the issues on appeal, including Consumers' termination of the contract in 1993, Consumers' total remaining exposure would be $24 million, for which Consumers previously accrued a loss. Consumers cannot predict the outcome of this appeal.\n4. Palisades Plant - Spent Nuclear Fuel Storage\nIn April 1993, the NRC amended its regulations, effective May 7, 1993, to approve the design of the dry spent fuel storage casks to be used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of February, 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals related to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. As of mid-August 1993, Consumers has loaded two dry storage casks with spent nuclear fuel and expects to load additional casks in 1994 prior to Palisades' 1995 refueling outage.\n5. CMS Energy's Exemption Under the Public Utility Holding Company Act of 1935\nCMS Energy is exempt from registration under PUHCA. In December 1991, the Attorney General and the MMCG filed a request with the SEC for the revocation of CMS Energy's exemption. In January 1992, CMS Energy responded to the revocation request affirming its position that it is entitled to the exemption. In April 1992, the MPSC filed a statement with the SEC that recommended that the SEC impose nine conditions on CMS Energy's exemption. The suggested conditions would (1) preclude CMS Energy's making non-utility investments without prior SEC approval; (2) prohibit CMS Energy's subsidiaries from making any upstream loans without prior SEC approval; (3) prohibit CMS Energy from pledging Consumers' assets as security without prior SEC approval; (4) prohibit the sale or transfer of utility securities or assets by CMS Energy without SEC concurrence; (5) prevent Consumers paying other than \"normal\" dividend; (6) require that all contracts and leases over $500,000 annual cost be filed with the SEC and MPSC; (7) require that access to the books and records of CMS Energy, its affiliates and their joint ventures, be provided to the SEC and the MPSC; (8) establish complaint procedures, with penalty provisions for addressing challenges to CMS Energy's compliance with the conditions; and (9) require that all pleadings filed with the SEC relating to the conditions be served contemporaneously on the MPSC. On July 9, 1993, the Attorney General submitted to the SEC a response to the MPSC's statement opposing the MPSC's recommendations and reiterating his argument that CMS Energy should not be allowed an exemption under PUHCA. On July 12, 1993, the MMCG submitted to the SEC a reply to CMS Energy's January 1992 response to the revocation request. On September 30, 1993, CMS Energy responded to the Attorney General's and the MMCG's July submissions. CMS Energy also contemporaneously submitted comments on the MPSC's April 1992 statement. In its response to the Attorney General and MMCG, CMS Energy again refuted the allegations made by the Attorney General and MMCG regarding CMS Energy's exemption, noting in particular that the matters complained of by the Attorney General and MMCG have all been addressed and resolved in proceedings before other regulatory and judicial authorities, primarily at the State level, with the Attorney General and MMCG participating. In its comments on the MPSC's April 1992 statement, CMS Energy updated events from the time the MPSC statement was filed during which the substantive issues underlying the MPSC's recommendations were resolved.\nShould the SEC revoke CMS Energy's current exemption from registration under PUHCA, CMS Energy could either become a registered holding company or be granted a new exemption, possibly subject to conditions similar to those recommended by the MPSC. Registration under PUHCA could require divestment by CMS Energy of either its gas utility or electric utility business by some future date following registration. As a registered company, CMS Energy could also be precluded from engaging in businesses that are not functionally related to its utility operations; in addition, SEC approval would be required for the issuance of securities by CMS Energy and its subsidiaries. If divestiture of Consumers' gas utility or its electric utility business ultimately were required, the effect on Consumers and CMS Energy would depend on the method of divestitures and the extent of the proceeds received, which cannot now be predicted.\nCMS Energy is vigorously contesting the revocation request and believes it will maintain the exemption. There has been no action taken by the SEC on this matter.\n6. Ludington Pumped Storage Plant\nIn September 1993, the Court of Appeals overturned the dismissal of a lawsuit filed by the Attorney General in September 1986 seeking damages from Consumers and Detroit Edison for alleged injuries to fishing resources due to the operation of the jointly owned Ludington Pumped Storage Plant. In his 1986 complaint, the Attorney General had sought $147.9 million (including interest) in damages for past injuries and approximately $89,000 per day for future damages, subject to adjustment based on the adequacy of the barrier net installed at the plant and other changed conditions. In a second lawsuit, filed in 1987, the Attorney General had also sought to have the plant's bottom lands lease agreement with the State declared void. The Court of Appeals' September 1993 ruling upheld the lower court's dismissal relating to the breach of claim, but would allow the Attorney General to continue his lawsuit for damages against Consumers and Detroit Edison, limiting the recovery of potential damages to those occurring not more than 3 years before filing the lawsuit in 1986. On October 14, 1993, the Court of Appeals made minor modifications to its opinion. Consumers and Detroit Edison have filed an application for leave to appeal with the Michigan Supreme Court seeking a reversal of the September 1993 Court of Appeals' Order and have the trial court's dismissal of the damages claim affirmed. The Attorney General filed a brief in opposition to Consumers' and Detroit Edison's application and also filed an application with the Michigan Supreme Court seeking reversal of the Court of Appeals' rulings as to the lease claims and the statute of limitations holding. The decision to grant or deny these applications is pending at the Michigan Supreme Court.\n7. Stray Voltage Lawsuit\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. On October 27, 1993, a complaint seeking certification as a class action suit was filed against Consumers in a local circuit court. The complaint alleged that in excess of a billion dollars of damages, primarily related to production by certain livestock owned by the purported class, were being incurred as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and has vigorously opposed the certification of the class and this suit. On March 11, 1994, the court decided to deny class certification for this complaint and to dismiss, subject to refiling as separate suits, the October lawsuit with respect to all but one of the named plaintiffs.\n8. Gas Supplier Dispute\nOn September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers, who have their contract price tied to the price Consumers pays Trunkline, have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers. To date, four suppliers have filed lawsuits, one in Canada, making these charges and seeking open pricing and/or renegotiation of the pricing provision for their contracts, and also seeking damages for breach of contract. Consumers is disputing these claims and has sought declaratory and other relief on this issue in Michigan courts against nine suppliers. Certain of the suppliers also allege that, absent successful renegotiation, they have the right to terminate their supply contracts with Consumers and have involved the MCV Partnership in the litigation claiming termination rights with respect to the MCV Partnership's supply contracts that were negotiated during the same period. Consumers has reached an agreement in principle to settle with three of the suppliers. Consumers cannot predict the outcome of this matter.\nAdditionally, three of these direct gas suppliers of Consumers made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\n9. Arbitration Proceedings Between Consumers and the MCV Partnership\nA dispute has arisen between the MCV Partnership and Consumers relating to the impact of the Settlement Order on the fixed energy charge payment called for in the PPA and Consumers' ability to exercise its rights under the regulatory out provision based on the issuance of the Settlement Order. In accordance with the dispute resolution provisions set out in the PPA, an arbitrator acceptable to both parties has been selected and the arbitration of this dispute has commenced. Consumers is unable to predict the outcome of such arbitration proceedings or of any possible settlement of the issues underlying this dispute. The lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or fraudulent misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\n10. 1991 Gas Rate Settlement\nOn December 19, 1991, the MPSC approved a settlement in Case No. U-10037 concerning Consumers' gas rates which had been entered into by Consumers and the MPSC Staff. The settlement provides that Consumers is required to make certain expenditures for gas operation and maintenance activities in 1992, and provides for refunds if these expenditure levels are not met, or if Consumers' gas earnings exceed certain levels. Both the Attorney General and ABATE opposed approval of the settlement agreement and ABATE sought rehearing of the December 19, 1991 Order. On April 15, 1992, the MPSC denied the rehearing request. Both ABATE and the Attorney General have appealed the MPSC's order. On March 10, 1994, the Court of Appeals issued a per curiam opinion affirming the MPSC order.\n11. Investigative Demand\nOn July 17, 1991, the Attorney General served a civil investigative demand upon Consumers and CMS Energy indicating that the Attorney General was investigating \"possible violations\" of the Michigan Antitrust Reform Act by CMS Energy and Consumers and certain of their affiliates, primarily in connection with potential acquisitions and dealings with electric generating companies including the MCV Partnership. CMS Energy and Consumers do not believe any violations of such Act have occurred. The Attorney General has not taken any action on this matter since 1991 and Consumers and CMS Energy believe that this investigation is no longer being pursued.\n12. Environmental Matters\nOn September 23, 1993, the EPA filed an administrative complaint against Consumers under Superfund and the Emergency Planning and Community Right-to-Know Act. The complaint alleges, after release of a certain hazardous substance at its J. H. Campbell coal-fired electric generating plant, that Consumers did not immediately notify the appropriate governmental authorities of the release as soon as Consumers had knowledge of the release. The complaint proposes penalties aggregating $100,000. Consumers is disputing these allegations.\nIn addition, Consumers is subject to various federal, state and local laws and regulations relating to the environment. Consumers has been named as a party to several actions involving environmental issues. However, based on its present knowledge and subject to future legal and factual developments, CMS Energy and Consumers believe that it is unlikely that these actions, individually or in total, will have a material adverse effect on their financial condition. See Item 1. BUSINESS. CONSUMERS AND CMS ENERGY ENVIRONMENTAL COMPLIANCE.\n13. Retail Wheeling Proceedings\nIn September 1992, in response to an application filed by ABATE, the MPSC issued an order commencing a joint contested case proceeding to consider experimental wheeling tariffs for Consumers and Detroit Edison. ABATE's proposal is that for an experimental period of five years utility customers with maximum demands of 5,000 kW or more be eligible for the retail wheeling tariff. Under the proposal, 60 megawatts of Consumers' load and 90 MW of Detroit Edison's load would be subject to displacement by retail wheeling. Consumers and Detroit Edison each opposed the proposed experimental retail wheeling tariff while the MPSC Staff cited concerns with the impact of the retail wheeling proposals on utility planning and procurement practices as well as regarding certain jurisdictional issues. In the PFD issued in August 1993, the ALJ determined that the MPSC could not order utilities to provide retail wheeling services and expressed concern regarding the proper pricing for this service should a utility voluntarily agree to provide the service.\n14. Wholesale Wheeling Proceedings\nConsumers has an approved open-access interconnection service schedule on file with the FERC for wholesale wheeling transactions. In 1992, Consumers also filed a separate but complementary open-access transmission tariff that would make both firm and non-firm transmission service available to eligible power generators, including investor-owned utilities, facilities that meet the ownership and technical requirements under PURPA, independent power producers, municipal and cooperative utilities. The FERC accepted the filing, effective May 2, 1992, subject to refund, and ordered a hearing before an ALJ. In September 1993, the ALJ issued an initial decision that would compel reductions of the tariff rates ranging from 25 percent to 65 percent. On November 1, 1993, Consumers filed exceptions with the FERC seeking reversal of the rate reductions proposed in the ALJ's initial decision. As of December 31, 1993, the amount of firm transmission service currently subject to the tariff is 23 MW.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nCMS Energy\nNone in the fourth quarter of 1993 for CMS Energy.\nConsumers\nNone in the fourth quarter of 1993 for Consumers. However, at a special meeting held on January 31, 1994, the shareholders of Consumers approved the creation of a new class of stock, Class A preferred stock. The stock vote taken on the matter was as follows:\nFor Against Abstain Total --- ------- ------- -----\nCommon and Preferred Stock 84,611,652 103,849 38,072 84,753,573\nPreferred Stock 502,863 103,849 38,072 644,784\nPART II\nITEM 5.\nITEM 5. MARKET FOR CMS ENERGY'S AND CONSUMERS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nCMS Energy\nMarket prices for CMS Energy's common stock and related security holder matters are contained herein in Item 8, CMS Energy's Quarterly Financial and Common Stock Information, which is incorporated by reference herein. Number of common shareholders at February 28, 1994 was 66,250.\nConsumers\nConsumers' common stock is privately held by its parent, CMS Energy, and does not trade in the public market. In May, August, November and December 1993, Consumers paid $57 million, $21.5 million, $33.5 million and $21 million cash dividends, respectively, on its common stock.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA.\nCMS Energy\nSelected financial information is contained in Item 8, CMS Energy's Selected Financial Information which is incorporated by reference herein.\nConsumers\nSelected financial information is contained in Item 8, Consumers' Selected Financial Information which is incorporated by reference herein.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nCMS Energy\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, CMS Energy's Management's Discussion and Analysis which is incorporated by reference herein.\nConsumers\nManagement's discussion and analysis of financial condition and results of operations is contained in Item 8, Consumers' Management's Discussion and Analysis which is incorporated by reference herein.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nIndex to Financial Statements:\nCMS Energy Page\nSelected Financial Information 51 Management's Discussion and Analysis 53 Consolidated Statements of Income 64 Consolidated Statements of Cash Flows 65 Consolidated Balance Sheets 66 Consolidated Statements of Long-Term Debt 68 Consolidated Statements of Preferred Stock 69 Consolidated Statements of Common Stockholders' Equity 70 Notes to Consolidated Financial Statements 71 Report of Independent Public Accountants 96 Quarterly Financial and Common Stock Information 97\nConsumers Page\nSelected Financial Information 101 Management's Discussion and Analysis 102 Consolidated Statements of Income 112 Consolidated Statements of Cash Flows 113 Consolidated Balance Sheets 114 Consolidated Statements of Long-Term Debt 116 Consolidated Statements of Preferred Stock 117 Consolidated Statements of Common Stockholder's Equity 118 Notes to Consolidated Financial Statements 119 Report of Independent Public Accountants 142 Quarterly Financial Information 143\nCMS Energy Corporation\n1993 Financial Statements\n(This page intentionally left blank)\nCMS Energy Corporation Management's Discussion and Analysis\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to utility, commercial and industrial customers, and 4) storage and transmission of natural gas.\nConsolidated 1993 Earnings\nConsolidated net income for 1993 totaled $155 million or $1.90 per share, compared to net losses of $297 million or $3.72 per share in 1992 and $276 million or $3.44 per share in 1991. The increased net income reflects the Settlement Order related to power purchases from the MCV Partnership. Earnings also reflect record-setting utility electric sales and gas deliveries and additional earnings from the growth of non-utility businesses.\nCash Position, Financing and Investing\nCMS Energy's primary ongoing source of operating cash is dividends from its principal subsidiaries. Consumers effected a quasi-reorganization as of December 31, 1992, which allowed it to resume paying common dividends (see Note 7 to the Consolidated Financial Statements). Consumers paid $133 million in common dividends in 1993 and declared a $16 million common dividend in January 1994 from 1993 earnings. CMS Energy also received cash dividends of $11 million from its non-utility subsidiaries. CMS Energy paid $49 million in cash dividends to common shareholders compared to $38 million in 1992. The $11 million increase reflects an annual increase of $.24 per share commencing third quarter 1993.\nCMS Energy's consolidated cash requirements are met by its operating and financing activities. In 1993 and 1992, CMS Energy's consolidated cash inflow from operations was derived mainly from Consumers' sale and transportation of natural gas and its sale and transmission of electrici- ty, and from NOMECO's sale of oil and natural gas. Consolidated cash from operations for 1993 primarily reflects Consumers' record-setting electric sales and gas deliveries and reduced after-tax cash shortfalls resulting from Consumers' purchases of power from the MCV Partnership.\nDuring 1992, CMS Energy's cash from operations decreased as compared to 1991 primarily due to higher operational expenditures and reduced electric rates. In 1991, CMS Energy generated cash primarily from its consolidated operating and investing activities, including $859 million of net proceeds from the sale of a majority of the MCV Bonds.\nOver the last three years, CMS Energy has used its consolidated cash to fund its extensive utility construction expenditures, to improve the reliability of its utility transmission and distribution systems and to expand its non-utility businesses. It also has used its cash to retire portions of long-term securities and to pay cash dividends.\nFinancing Activities\nIn October 1993, CMS Energy issued 4.6 million shares of common stock at a price of $26 5/8. The net proceeds of $119 million were used to reduce existing debt and for general corporate purposes. During 1993, Consumers significantly reduced its future interest charges by retiring approximately $51 million of high-cost outstanding debt and refinancing approximately $573 million of other debt at lower interest rates. In November 1993, NOMECO amended the terms of its loan agreement and increased the amount to $110 million. For further information, see Note 7.\nInvesting Activities\nCapital expenditures (excluding assets placed under capital leases of $58 million), deferred DSM costs and investments in unconsolidated subsidiaries totaled $708 million for 1993 as compared to $525 million in 1992. CMS Energy's expenditures for its utility, independent power production, oil and gas exploration and production, and gas transmission and marketing business segments were $503 million, $110 million, $81 million and $14 million, respectively.\nIn December 1993, Consumers sold $309 million of MCV Bonds it held and used the net proceeds to temporarily reduce short-term borrowings and ultimately plans to reduce long-term debt and to finance its construction program.\nOutlook\nCMS Energy estimates that capital expenditures, including DSM, new lease commitments and investments in unconsolidated subsidiaries, will total approximately $2.2 billion over the next three years.\nIn Millions Years Ended December 31 1994 1995 1996 ---- ---- ---- Electric and gas utility $553 $461 $471 Oil and gas exploration and production 117 90 100 Independent power production 84 99 98 Gas transmission and marketing 38 40 45 ---- ---- ---- $792 $690 $714 ==== ==== ====\nCMS Energy is required to redeem or retire approximately $796 million of long-term debt during 1994 through 1996. Cash generated by operations is expected to satisfy a substantial portion of these capital expenditures and debt retirements. Additionally, CMS Energy will evaluate the capital markets in 1994 as a source of financing its subsidiaries' investing activities.\nCMS Energy filed a shelf registration statement with the SEC in January 1994 covering the issuance of up to $250 million of unsecured debt securities. The net proceeds will be used to reduce the amount of CMS Energy Notes outstanding and for general corporate purposes. In October 1993, Consumers received MPSC authorization and is proceeding to issue $200 million of preferred stock in 1994.\nConsumers has several other available sources of credit including unsecured, committed lines of credit totaling $165 million and a $470 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1994. Consumers uses short-term borrowings to finance working capital, seasonal fuel inventory, and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. As of December 31, 1993 and 1992, receivables sold totaled $285 million and $225 million, respectively. On February 15, 1993, Consumers increased the level of receivables sold to $335 million. In February 1994, Consumers called or redeemed approximately $101 million of first mortgage bonds (see Note 7).\nElectric Utility Operations\nComparative Results of Operations\nElectric Pretax Operating Income: The improvement in 1993 pretax operating income compared to 1992 reflects an increase of $126 million relating to the resolution of the recoverability of MCV power purchase costs under the PPA and increased electric system sales of $45 million, partially offset by higher costs to improve system reliability. The 1992 decrease of $66 million from the 1991 level primarily resulted from an increased emphasis on system reliability improvements and decreased electric rates resulting from the full-year impact of a mid-1991 rate decrease.\nElectric Sales: Electric system sales in 1993 totaled a record 31.7 billion kWh, a 3.8 percent increase from 1992 levels. In 1993, residential and commercial sales increased 3.4 percent and 3.0 percent, respectively, while industrial sales increased 6.5 percent. Growth in the industrial sector was the strongest in the auto-related segments of fabricated and primary metals and transportation equipment. Electric system sales in 1992 totaled 30.5 billion kWh, essentially unchanged from the 1991 levels.\nPower Costs: Power costs for 1993 totaled $908 million, a $31 million increase from the corresponding 1992 period. This increase primarily reflects greater power purchases from outside sources to meet increased sales demand and to supplement decreased generation at Palisades due to an extended outage. Power costs for 1992 totaled $877 million, a $17 million decrease as compared to 1991.\nOperation and Maintenance: Increases in other operation and maintenance expense for 1993 and 1992 reflected increased expenditures to improve electric system reliability.\nDepreciation: The increased depreciation for 1993 reflects additional capital investments in plant. The 1992 increase resulted from higher depreciation rates, increased amortization of abandoned nuclear investment and increased nuclear plant decommissioning expense.\nElectric Utility Rates\nPower Purchases from the MCV Partnership: Consumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1993 1994 thereafter - ---- ----- ----- ---------- MW 1,023 1,132 1,240\nSince 1990, recovering capacity and fixed-energy costs for power purchased from the MCV Partnership has been a significant issue. Effective January 1, 1993, the Settlement Order allowed Consumers to recover from electric retail customers substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership, significantly reducing the amount of future underrecoveries for these power costs. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nPrior to the Settlement Order, Consumers had recorded losses for underrecoveries from 1990 through 1992. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order, based on management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. The after-tax expense for the time value of money for the $343 million loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. If Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Estimates for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Expected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level.\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. As of December 31, 1993, these amounts total $26 million. Although Consumers intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action. For further information regarding power purchases from the MCV Partnership, see Note 3.\nPSCR Matters: Consumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage and any associated delays. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies.\nElectric Rate Case: Consumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. In March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported a performance incentive which Consumers also supported. For further information, see Note 4.\nElectric Conservation Efforts\nIn October 1993, Consumers completed the customer participation portion of several incentive-based DSM programs which were designed to encourage the efficient use of energy, primarily through conservation measures. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on electric common equity may be adjusted either upward by up to one percent or downward by up to two percent, for one year following reconciliation hearings with the MPSC. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives (see Note 4).\nElectric Capital Expenditures\nCMS Energy estimates capital expenditures, including DSM and new lease commitments, related to its electric utility operations of $396 million for 1994, $324 million for 1995 and $332 million for 1996.\nElectric Environmental Matters and Health Concerns\nThe 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions will require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nIn 1990, the State of Michigan passed amendments to the Environmental Response Act, under which Consumers expects that it will ultimately incur costs at a number of sites, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. CMS Energy and Consumers believe costs incurred for both investigation and any required remedial actions would be recoverable from electric utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers and CMS Energy believe that it is unlikely that their liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on their financial positions or results of operations.\nElectric Outlook\nConsumers expects economic growth, competitive rates and other factors to increase the demand for electricity within its service territory by approximately 1.8 percent per year over the next five years. For the near term, Consumers currently plans a reserve margin of 20 percent and expects to fill the additional capacity required through long- and short-term power purchases. Long-term purchased power will likely be obtained through a competitive bidding solicitation process utilizing the framework established by the MPSC in 1992. Capacity from the MCV Facility above the levels authorized by the MPSC may be offered by Consumers in connection with the solicitation.\nA recent NRC review of Consumers' performance at Palisades showed a decline in performance. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. To provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management which is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nConsumers is currently collecting $45 million annually from electric retail customers for the future decommissioning of its two nuclear plants. Consumers believes these amounts will be adequate to meet current decommissioning cost estimates. For further information regarding nuclear decommissioning, see Note 2.\nConsumers' on-site storage pool at Palisades is at capacity, and it is unlikely that the DOE will begin accepting any spent nuclear fuel by the originally scheduled date in 1998. Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary storage. Several appeals relating to NRC approval of the casks are now pending at the U.S. Sixth Circuit Court of Appeals. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers has experienced an increase in complaints in 1993 relating primarily to the effect of so-called stray voltage on certain livestock. A complaint seeking certification as a class action suit has been filed against Consumers alleging significant damages, primarily related to certain livestock, which Consumers believes to be without merit (see Note 12).\nSome of Consumers' larger industrial customers are exploring the possibility of constructing and operating their own on-site generating facilities. Consumers is actively working with these customers to develop rate and service alternatives that are competitive with self-generation options. Although Consumers' electric rates are competitive with other regional utilities, Consumers has on file with the FERC two open access interconnection tariffs which could have the effect of increasing competition for wholesale customers. As part of its current electric rate case, Consumers has requested that the MPSC reduce the level of rate subsidization of residential customers by commercial and industrial customers so as to further improve rate competitiveness for its largest customers.\nThe MPSC has completed a hearing on a proposal by ABATE to create an experimental retail wheeling tariff. Certain other parties have proposals in support of retail wheeling under development. In August 1993, an ALJ recommended that the MPSC reject the proposed experiment. An MPSC order is expected early in 1994.\nGas Utility Operations\nComparative Results of Operations\nGas Pretax Operating Income: For 1993, pretax operating income increased $38 million compared to 1992, reflecting higher gas deliveries (both sales and transportation volumes) and more favorable regulatory recovery of gas costs related to transportation. During 1992, gas pretax operating income increased $45 million from the 1991 level, essentially for many of the same reasons as the current period.\nGas Deliveries: Gas sales and gas transported in 1993 totaled 410.6 bcf, a 6.9 percent increase from 1992. In 1992, gas sales and gas transported totaled 384.1 bcf, a 6.1 percent increase from 1991 deliveries.\nGas Utility Rates\nConsumers currently plans to file a request in 1994 with the MPSC to increase its gas rates. The request would include, among other things, costs for postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. A final order should be received approximately nine to twelve months after the request is filed.\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. The Trunkline contract covers gas deliveries through October 1994 and is at a price reduced in September 1993. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims.\nIn 1992, the FERC issued Order 636, which makes a number of significant changes to the structure of the services provided by interstate natural gas pipelines to be implemented by the 1993-94 winter heating season. Consumers is a significant purchaser of gas from an interstate pipeline (Trunkline) and is a major transportation customer of a number of pipelines. Management believes that Consumers will recover any transition costs it may incur and such restructuring will not have a significant impact on its financial position or results of operations.\nIn July 1993, Michigan Gas Storage submitted a notice of rate change with the FERC to revise its operation and maintenance expenses for 1993 and update plant costs to reflect the addition of approximately $27 million of new plant additions in 1993 and began collecting the revised rates subject to refund and a hearing in February 1994. Hearings or settlement conferences will follow. For further information regarding gas utility rates, see Note 4.\nGas Capital Expenditures\nCMS Energy estimates capital expenditures, including new lease commitments, related to its gas utility operations of $99 million for 1994, $88 million for 1995 and $81 million for 1996.\nGas Environmental Matters\nUnder the Environmental Response Act, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation/feasibility studies for three of these sites. Work plans for remedial investigation/feasibility studies for four other sites have also been prepared. The DNR has approved two of the three plans for remedial investigation/feasibility studies submitted and is currently reviewing the one remaining. Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study, which may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. CMS Energy and Consumers believe costs incurred for both investigation and any required remedial actions would be recoverable from gas utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nGas Outlook\nIn 1993, Consumers purchased approximately 85 percent of its required gas supply under long-term contracts, and the balance on the spot market. Trunkline supplied approximately 41 percent of the total requirement. Consumers expects gas supply reliability to be ensured through long-term supply contracts, with purchases in the short-term spot market when economically beneficial. Management believes that Consumers' ability to purchase gas during the off-season and store it in its extensive underground storage facilities will continue to help provide customers with low-cost, competitive gas rates.\nConsumers anticipates growth in gas deliveries of approximately 0.6 percent per year over the next five years. Management believes that environmental benefits, along with the federal requirements included in the Energy Act, create an opportunity for growth in the natural gas vehicle industry.\nOil and Gas Exploration and Production\nPretax Operating Income\n1993 pretax operating income decreased $4 million from 1992, primarily reflecting lower average market prices for oil and $10 million of international write-offs, partially offset by higher gas and oil sales volumes and higher average market prices for gas. 1992 pretax operating income decreased $7 million from 1991, primarily due to lower average market prices for oil, partially offset by increased oil and gas sales volumes.\nCapital Expenditures\nDuring 1993, CMS Energy's oil and gas exploration and production capital expenditures were $81 million. Most expenditures were made to develop existing proven reserves -- oil reserves in Ecuador which will start production in 1994 and Antrim Shale gas in northern Michigan.\nCMS Energy currently plans to invest $307 million over the next three years in its oil and gas exploration and production operations. These anticipated capital expenditures primarily reflect continued development of Ecuador oil and Antrim Shale gas and reserve acquisitions. International focus will remain on Latin America and the Pacific Rim region.\nIndependent Power Production\nPretax Operating Income\n1993 pretax operating income increased $21 million, primarily reflecting the addition of new electric generating capacity and improved equity earnings and operating efficiencies. CMS Energy's ownership share of sales and revenues increased 24 percent and 18 percent, respectively, over the prior year.\nCapital Expenditures\nIn 1993, capital expenditures were $110 million, including investments in unconsolidated subsidiaries. These expenditures were primarily used to obtain ownership interests in an additional 309 MW of owned operating capacity or a 40 percent increase from December 31, 1992.\nIn April 1993, CMS Generation acquired a 50 percent interest in the Lyonsdale cogeneration plant, a 19 MW power plant in upstate New York. CMS Generation has invested $9 million in the project and additional investments relating to this project are expected to be immaterial.\nIn May 1993, a consortium including CMS Generation purchased an 88 percent share in the 650 MW San Nicolas power plant near Buenos Aires, Argentina. As of December 31, 1993, CMS Generation's share of the consortium is 18.6 percent and it has provided notice to exercise its option to increase its share to 21 percent. The plant sells power under long-term contracts to two utilities and Argentina's electric grid system. CMS Generation has invested $21 million in the partnership through December 31, 1993 and plans to invest approximately $3 million in 1994 in exercising its option.\nIn June 1993, CMS Generation was involved in the formation of Scudder Latin American Trust for Independent Power as a lead partner. The fund, which has investment commitments of $25 million from each of the four lead partners, will invest in electric generation and infrastructure resulting from the development of new power generating capacity. CMS Generation has contributed $.5 million through December 31, 1993 and estimates contributions of up to $11 million in 1994.\nIn July 1993, an investment company including CMS Generation S. A. acquired the rights to a 59 percent ownership interest in two hydroelectric power plants on the Limay River in western Argentina. These plants have a total generating capacity of 1,320 MW. The remaining interest in the project is to be held 39 percent by the Argentine provincial government and 2 percent by the plant employees. CMS Generation S.A. has a 25 percent ownership interest in the investment company. The investment company secured a 30-year concession under a government privatization program and in August 1993, began operating these power plants. CMS Generation S.A. entered into letter of credit agreements to support the acquisition. As of December 31, 1993, CMS Energy had approximately $41 million of guarantees relating to this agreement which were reduced to less than $15 million in January 1994. CMS Generation has invested $64 million in equity and loans and plans to invest up to an additional $2 million in 1994.\nCMS Generation has a 50 percent ownership interest and has invested, through the Oxford/CMS Development Limited Partnership, $7 million in the Exeter waste tire-fueled/electric generation facility near Sterling, Connecticut. Based on a financial restructuring completed in 1993, CMS Generation may be obligated to invest up to an additional $2 million. The 26.5 MW Exeter facility has a capacity of processing 10 million waste tires per year and sells its capacity and energy to Connecticut Light and Power Company under a long-term agreement.\nEffective November 1, 1993, CMS Generation acquired a 50 percent ownership interest in an 18 MW wood waste-fueled electric generation facility located near Chateaugay, New York for approximately $5 million and became the operator March 1, 1994. The facility sells its entire electric output to New York State Electric and Gas Corporation under a long-term power purchase agreement. CMS Generation expects no additional investment relating to this project.\nCMS Energy currently plans to invest $281 million relating to its independent power production operations over the next three years, primarily in domestic and international subsidiaries and partnerships. CMS Generation is involved with partnerships that have signed power contracts to construct power plant facilities capable of producing a total of 885 MW of operating capacity in Michigan, Tamil Nadu, India, and two projects in Batangas, Philippines. CMS Generation will also pursue acquisitions in Latin America, southern Asia and the Pacific Rim region.\nGas Transmission and Marketing\nPretax Operating Income\n1993 pretax operating income increased $2 million over 1992, reflecting earnings growth from existing and new gas transportation projects and increased natural gas marketed. In 1993, 60 bcf was marketed compared to 45 bcf in 1992.\nCapital Expenditures\nDuring 1993, CMS Energy's non-utility gas companies made capital expenditures of $14 million and formed two marketing partnerships which will provide natural gas marketing services throughout the Appalachian region of the United States and in Chicago and northern Illinois.\nIn November 1993, CMS Gas Transmission acquired an existing $4 million gas gathering system in the Antrim Shale region of Michigan's Lower Peninsula, which was placed into service in December 1993. CMS Gas Transmission began an $11 million expansion of its carbon dioxide processing facility, with completion expected in March 1994. In December 1993, they signed a letter of intent to invest $18 million to acquire 50 percent ownership in an existing 5 bcf high deliverability salt cavern storage facility on the Gulf Coast of Texas.\nCMS Energy currently plans to invest $123 million over the next three years relating to its non-utility gas operations. These investments would reflect the significant expansion of certain northern Michigan gas pipeline and carbon dioxide removal plant facilities. It will continue to pursue development of natural gas storage, gas gathering and pipeline operations both domestically and internationally and work toward the development of a Midwest \"market center\" for natural gas through strategic alliances and asset acquisition and development.\nOther\nOther Income: The 1993 other income level reflects lower Midland-related losses than experienced in 1992. The 1992 loss included a $343 million charge related to the Settlement Order. The 1991 loss included $294 million related to an MPSC order received in 1991 that allowed Consumers to recover only $760 million of remaining abandoned Midland investment.\nFixed Charges: Fixed charges for 1993 increased $22 million from 1992 and primarily reflect debt outstanding with higher rates of interest in 1993. The significant decrease in fixed charges in 1992 from 1991 primarily reflects Consumers' program aimed at significantly reducing its debt and the refinancing of debt at lower interest rates.\nPublic Utility Holding Company Act Exemption: CMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. On April 15, 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nCMS Energy Corporation Notes to Consolidated Financial Statements\n1: Corporate Structure\nCMS Energy is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the principal subsidiary of CMS Energy. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry. Enterprises is engaged in several non-utility energy-related businesses including: 1) oil and gas exploration and production, 2) development and operation of independent power production facilities, 3) gas marketing services to utility, commercial and industrial customers, and 4) transmission and storage of natural gas.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation\nThe consolidated financial statements include CMS Energy, Consumers and Enterprises and their wholly owned subsidiaries. CMS Energy eliminates all material transactions between its consolidated companies. CMS Energy uses the equity method of accounting for investments in its companies and partnerships where it has more than a 20 percent but less than a majority ownership interest and includes these results in operating revenue. For the years ended December 31, 1993, 1992 and 1991 equity earnings (losses) were $17 million, $(6) million, and $(8) million, respectively.\nGas Inventory\nConsumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion\nProperty repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. In May 1991, the MPSC approved an increase of approximately $15 million annually in Consumers' electric and common utility plant depreciation rates. The composite depreciation rate for electric utility property was 3.4 percent for 1993 and 1992 and 3.3 percent for 1991. The composite rate for gas utility plant was 4.4 percent for 1993 and 4.3 percent for 1992 and 1991.\nNOMECO follows the full-cost method of accounting and, accordingly, capitalizes its exploration and development costs, including the cost of non-productive drilling and surrendered acreage, on a country-by-country basis. The capitalized costs in each cost center are being amortized on an overall units-of-production method based on total estimated proven oil and gas reserves.\nThe composite rates for Consumers' common property, NOMECO's other property, and other property of CMS Energy and its subsidiaries were 4.5 percent in 1993, 4.7 percent in 1992 and 4.1 percent in 1991.\nNew Accounting Standards\nIn November 1992, the FASB issued SFAS 112, Employers' Accounting for Postemployment Benefits, which CMS Energy adopted January 1, 1994. CMS Energy pays for several postemployment benefits, the most significant being workers compensation. Because CMS Energy's postemployment benefit plans do not vest or accumulate, the standard did not materially impact CMS Energy's financial position or results of operations. For new accounting standards related to financial instruments, see Note 8.\nNuclear Fuel, Decommissioning and Other Nuclear Matters\nConsumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities under various payment options. However, in a statement released February 17, 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. The DOE is exploring options to offset the costs incurred by nuclear utilities in continuing to store spent nuclear fuel on site. For fuel burned after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers it through electric rates and remits it to the DOE quarterly. Consumers has elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983 until the spent fuel is delivered to the DOE. As of December 31, 1993, Consumers has recorded a liability to the DOE of $90 million, including interest, to dispose of spent nuclear fuel burned before April 7, 1983. Consumers has been recovering through electric rates the amount of this liability, excluding a portion of interest. Consumers' liability to the DOE becomes due when the DOE takes possession of Consumers' spent nuclear fuel, which was originally scheduled to occur in 1998.\nIn April 1993, the NRC approved the design of the dry spent fuel storage casks now being used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of mid- February 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals relating to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. Consumers loaded two dry storage casks with spent nuclear fuel in 1993 and expects to load additional casks in 1994 prior to Palisades' 1995 refueling. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers currently estimates decommissioning costs (decontamination and dismantlement) of $208 million and $399 million, in 1993 dollars, for the Big Rock Point and Palisades nuclear plants, respectively. At December 31, 1993, Consumers had recorded $171 million of decommissioning costs and classified the obligation as accumulated depreciation. In January 1987, Consumers began collecting estimated costs to decommission its two nuclear plants through a monthly surcharge to electric customers which currently totals $45 million annually. Consumers expects to file updated decommissioning estimates with the MPSC on or before March 31, 1995. Amounts collected from electric retail customers are deposited in trust. Trust earnings are recorded as an investment with a corresponding credit included in accumulated depreciation. The total amount of the trust will be available for decommissioning Big Rock Point and Palisades at the end of their respective license periods in 2000 and 2007. Consumers believes the amounts being collected are adequate to meet its currently estimated decommissioning costs and current NRC requirements.\nIn November 1993, Palisades returned to service following a planned refueling and maintenance outage that had been extended due to several unanticipated repairs. The results of an NRC review of Consumers' performance at Palisades published shortly thereafter showed a decline in performance ratings for the plant. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. In order to provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management. The evaluation is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nPlateau Resources Ltd.\nIn August 1993, Consumers sold its ownership interest in Plateau to U. S. Energy Corp. As a result of the sale, approximately $14 million of Plateau's cash and cash equivalents, other assets and liabilities, including certain future decommissioning, environmental and other contingent liabilities were transferred to U. S. Energy Corp. In view of prior write-offs, this transaction did not result in any material gains or additional losses.\nReclassifications\nCMS Energy and the MCV Partnership (see Note 16) have reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect the net losses for the years presented.\nRelated-Party Transactions\nIn 1993, 1992, and 1991, Consumers purchased $52 million, $36 million and $26 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Affiliates of CMS Energy sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $27 million, $21 million and $19 million for 1993, 1992 and 1991, respectively. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 16. Other related-party transactions are immaterial.\nRevenue and Fuel Costs\nConsumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers also accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until Consumers bills these unrecovered costs or refunds the excess recoveries to customers after reconciliation hearings conducted before the MPSC.\nUtility Regulation\nConsumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther\nFor significant accounting policies regarding cash equivalents, see Note 14; for income taxes, see Note 5; and for pensions and other postretirement benefits, see Note 10.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to supply electricity and steam to The Dow Chemical Company and to sell electricity to Consumers for a 35-year period beginning in March 1990. At December 31, 1993, Consumers, through its subsidiaries, held the following assets related to the MCV: 1) CMS Midland owned a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings held through the FMLP a 35 percent lessor interest in the MCV Facility. In late 1993, Consumers sold its remaining $309 million investment in the MCV Bonds.\nPower Purchases from the MCV Partnership\nConsumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1991 1992 1993 1994 thereafter - ---- ----- ----- ----- ----- ---------- MW 806 915 1,023 1,132 1,240\nDuring 1992 and 1991, the MPSC only allowed Consumers to recover costs of power purchased from the MCV Partnership based on delivered energy at rates less than Consumers paid for 840 MW in 1992 and 806 MW in 1991. As a result, Consumers recorded after-tax losses of $86 million in 1992 and $124 million in 1991.\nOn March 31, 1993, the MPSC approved, with modifications, the Revised Settlement Proposal which had been co-sponsored by Consumers, the MPSC staff and 10 small power and cogeneration developers. These parties accepted the Settlement Order and the MCV Partnership confirmed that it did not object to its terms. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nThe Settlement Order determined the cost of power purchased from the MCV Partnership that Consumers can recover from its electric retail customers and will significantly reduce the amount of future underrecoveries for these power costs. Effective January 1, 1993, the Settlement Order allowed Consumers to recover substantially all of the payments for its on- going purchase of 915 MW of contract capacity from the MCV Partnership. Capacity and energy purchases from the MCV Partnership above the 915 MW level can be competitively bid into Consumers' next solicitation for power or, if necessary, utilized for current power needs with a prudency review and a pricing recovery determination in annual PSCR cases. In either instance, the MPSC would determine the levels of recovery from customers for the power purchased. The Settlement Order also provides Consumers the right to remarket all of the remaining capacity to third parties. The PPA requires Consumers to pay a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge based primarily on Consumers' average cost of coal consumed. The Settlement Order provided Consumers two options for the recovery that could be used for capacity charges paid to the MCV Partnership. Under the option selected, Consumers is scheduling deliveries of energy from the MCV Partnership whenever it has energy available up to hourly availability limits, or \"caps,\" for the 915 MW of capacity authorized for recovery in the Settlement Order. Consumers can recover an average 3.62 cents per kWh capacity charge and the prescribed energy charges associated with the scheduled deliveries within the caps, whether or not those deliveries are scheduled on an economic basis. Through December 31, 1997, there is no cap applied during on-peak hours to Consumers' recovery for the purchase of capacity made available within the 915 MW authorized. Recovery for purchases during off-peak hours is capped at 80 percent in 1993, 82 percent in 1994 and 1995, 84 percent in 1996 and 1997, increasing to 88.7 percent in 1998 and thereafter at which time the 88.7 percent cap is applicable during all hours. For all economic energy deliveries above the caps to 915 MW, the option also allows Consumers to recover 1/2 cent per kWh capacity payment in addition to the corresponding energy charge.\nIn December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss included management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. Because the calculation of the 1992 loss depended in part upon estimates of future unregulated sales of energy to third parties, a more conservative or risk-free investment rate of 7 percent was used to calculate $188 million of the total $343 million after-tax loss. The remaining portion of the loss was calculated using an 8.5 percent discount rate reflecting Consumers' incremental borrowing rate as required by SFAS 90, Regulated Enterprises- Accounting for Abandonments and Disallowances of Plant Costs. The after- tax expense for the time value of money for the loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries, including fixed energy charges, associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. However, if Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Consumers' estimates of its future after-tax cash underrecoveries and possible additional losses for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level.\nThe undiscounted, after-tax amount of the $343 million loss was $789 million. At December 31, 1993, the after-tax present value of the Settlement Order liability had been reduced to $307 million, which reflects after-tax cash underrecoveries related to capacity totaling $(54) million, after-tax accretion expense of $23 million and a $(5) million adjustment due to the 1993 corporate tax rate change (see Note 5).\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. In connection with the MPSC's approval of the Revised Settlement Proposal, Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership even though Consumers may not be recovering these costs. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. Although Consumers believes its position on arbitration is sound and intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. As of December 31, 1993, approximately $20 million has been escrowed by Consumers and is included in Consumers' temporary cash investments. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\nPSCR Matters: Consistent with the terms of the Settlement Order, Consumers has withdrawn its appeals of various MPSC orders issued in connection with the 1992, 1991 and 1990 PSCR cases. Consumers also agreed not to appeal any MCV-related issues raised in future orders for these plan cases and related reconciliations to the extent those issues are resolved by the Settlement Order. Consumers made refunds, including interest, of $69 million in 1993 and $29 million in 1992 to customers for overrecoveries in connection with the 1991 and 1990 PSCR reconciliation cases, respectively. These amounts were included in losses recorded prior to 1993. In 1992, Consumers recovered MCV power purchase costs consistent with the MPSC's 1992 plan case order, and does not anticipate that any MCV-related refunds will be required.\n4: Rate Matters\nElectric Rate Case\nConsumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. Consumers' request included increased future expenditures primarily related to capital additions, DSM programs, operation and maintenance, higher depreciation and postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. The filing also proposed experimental incentive provisions that would either reward or penalize Consumers, based on its operating performance. In addition, Consumers would share any returns above its MPSC-authorized level with customers in exchange for the ability to earn not lower than one percentage point below its authorized level.\nIn March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported the performance incentive but not the shared return mechanism discussed above.\nAbandoned Midland Project: In July 1984, Consumers abandoned construction of its unfinished nuclear power plant located in Midland, Michigan, and subsequently took a series of write-downs. In May 1991, Consumers began collecting $35 million pretax annually for the next 10 years and is amortizing the assets against current income over the recovery period using an interest method. Amortization for 1993, 1992 and 1991 was $28 million, $28 million and $18 million, respectively.\nConsumers was not permitted to earn a return on the portion of the abandoned Midland investment for which the MPSC was allowing recovery. Therefore, under SFAS 90, the recorded losses described above included amounts that reduced the recoverable asset to the present value of future recoveries. During the remaining recovery period, part of the prior losses will be reversed to adjust the unrecovered asset to its present value and is reflected as accretion income. An after-tax total of approximately $35 million of the prior losses remains to be included in accretion income through April 2001. Several parties, including the Attorney General, have filed claims of appeal with the Court of Appeals regarding MPSC orders issued in May and July 1991 that specified the recovery of abandoned investment.\nElectric DSM: As a result of settlement discussions regarding DSM and an MPSC order in July 1991, Consumers agreed to spend $65 million over two years on DSM programs. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent. This adjustment, if implemented, would be applied to Consumers' retail electric tariff rates and be in effect for one year following reconciliation hearings with the MPSC that are expected to be initiated in the first quarter of 1994. The estimated revenue effects of the potential adjustment range from an $11 million increase to a $22 million decrease. Consumers believes it will receive an increase on its return on common equity.\nOn October 1, 1993, Consumers completed the customer participation portion of these programs and as part of its current electric rate case has requested MPSC authorization to continue certain programs in 1994. Consumers has also requested recovery of DSM expenditures which exceeded the $65 million level. Consumers is deferring program costs and amortizing the costs over the period these costs are being recovered from its customers in accordance with an accounting order issued by the MPSC in September 1992. The unamortized balance of deferred costs at December 31, 1993 and 1992 was $71 million and $25 million, respectively.\nPSCR Issues\nConsumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage. Any finding of delay due to imprudence could result in disallowances of a portion of replacement power costs. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies. As of December 31, 1993, Consumers' remaining estimated liability was approximately $34 million. Consumers has a regulatory asset of $34 million for the expected recovery of this amount in electric rates. GCR Issues\nIn connection with its 1991 GCR reconciliation case, Consumers refunded $36 million, including interest, to its firm sales and transportation rate customers in April 1992. Consumers accrued the full amount for this refund in 1991.\nThe MPSC issued an order during 1993 that approved an interim settlement agreement for the 12 months ended March 31, 1993. As a result of the settlement, Consumers refunded in August 1993, to its GCR and transportation customers, approximately $22 million, including interest. Consumers previously accrued amounts sufficient for this refund.\nThe MPSC, in a February 1993 order, provided that the price payable to certain intrastate gas producers by Consumers be reduced prospectively. As a result, Consumers was not allowed to recover approximately $13 million of costs incurred prior to February 8, 1993. In 1991, Consumers accrued a loss sufficient for this issue. Future disallowances are not anticipated, unless the remaining appeals filed by the intrastate producers are successful.\nIn 1992, the FERC approved a settlement involving Consumers, Trunkline and certain other parties, which resolved numerous claims and proceedings concerning Trunkline liquified natural gas costs. The settlement represents significant gas cost savings for Consumers and its customers in future years. As part of the settlement, Consumers will not incur any transition costs from Trunkline as a result of FERC Order 636. In November 1992, Consumers had recorded a liability and regulatory asset for the principal amount of payments to Trunkline over a five-year period and a regulatory asset. On May 11, 1993, the MPSC approved a separate settlement agreement that provides Consumers with full recovery of these costs over a five-year period. At December 31, 1993, Consumers' remaining liability and regulatory asset was $116 million.\nOther\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. On September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements. The current contract covers gas deliveries through October 1994 and is at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims. Additionally, three of these direct gas suppliers of Consumers have made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on the financial statements.\n5: Income Taxes\nCMS Energy and its subsidiaries (including Consumers) file a consolidated federal income tax return. Income taxes are generally allocated to each subsidiary based on each subsidiary's separate taxable income. In 1992, CMS Energy implemented SFAS 109, Accounting for Income Taxes. Deferred tax assets and liabilities are classified as current or noncurrent based on the classification of the related asset or liability, for all temporary differences. Consumers began practicing full deferred tax accounting for temporary differences arising after January 1, 1993 as authorized by a generic MPSC order. The generic order reduces the amount of regulatory assets and liabilities that otherwise could have arisen in future periods by allowing Consumers to reflect the income statement effect in the period temporary differences arise.\nCMS Energy uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. The AMT requires taxpayers to perform a second separate federal tax calculation based on a flat rate applied to a broader tax base. AMT is the amount by which this \"broader-based\" tax exceeds regular tax. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 increased the statutory federal tax rate from 34 percent to 35 percent effective January 1, 1993. The cumulative effect of this tax rate change has been reflected in CMS Energy's financial statements.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1993 1992 1991(a) - ----------------------- ------- ------ -------- Current federal income taxes $ 19 $ 39 $ 13 Deferred income taxes 67 (177) (143) Deferred income taxes - tax rate change (1) - - Deferred ITC, net (10) (8) 36 ------- ------ ------ $ 75 $(146) $ (94) ======= ====== ======\nOperating $ 92 $ 22 $ 25 Other (17) (168) (119) ------- ------ ------ $ 75 $(146) $ (94) ======= ====== ======\n(a) The 1991 provision for income taxes was before an extraordinary item that had related deferred income taxes of approximately $7 million.\nThe principal components of CMS Energy's deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1993 1992 - ----------- ------- -------- Property $(580) $ (521) Unconsolidated investments (194) (128) Postretirement benefits (Note 10) (180) (167) Abandoned Midland project (Note 4) (57) (60) Employee benefit obligations (includes postretirement benefits of $182 and $168) (Note 10) 204 189 MCV power purchases - settlement (Note 3) 165 177 AMT carryforward 110 83 ITC carryforward (expires 2005) 48 52 Other (8) 5 ------- -------- $ (492) $ (370) ======== ========\nGross deferred tax liabilities $(1,571) $(1,416) Gross deferred tax assets 1,079 1,046 -------- -------- $ (492) $ (370) ======== ========\nThe actual income tax expense (benefit) differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1993 1992 1991 ------- ------- ------- Net income (loss) before preferred dividends and extraordinary item $ 166 $(286) $(252) Income tax expense (benefit) 75 (146) (94) ------- ------- ------- 241 (432) (346) Statutory federal income tax rate x 35% x 34% x 34% -------- ------- ------- Expected income tax expense (benefit) 84 (147) (118) Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 35 Differences in book and tax depreciation not previously deferred 6 9 8 ITC amortization and utilization (12) (11) (9) Other, net (8) (2) (10) ------- ------- ------- $ 75 $ (146) $(94) ======= ======= =======\n6: Short-Term Financings\nConsumers has authorization from the FERC to issue or guarantee up to $900 million of short-term debt through December 31, 1994. Consumers has a $470 million facility that is used to finance seasonal working capital requirements and unsecured, committed lines of credit aggregating $165 million. As of December 31, 1993, $235 million and $24 million were outstanding at weighted average interest rates of 4.0 percent and 3.9 percent, respectively. Further, Consumers has an established $500 million trade receivables purchase and sale program. As of December 31, 1993 and 1992, receivables sold under the agreement totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\n7: Capitalization\nCMS Energy\nCapital Stock: CMS Energy's Articles permit it to issue up to 250 million shares of common stock at $.01 par value and up to 5 million shares of preferred stock at $.01 par value. Under its two and one-half year Secured Credit Facility and Indenture pursuant to which the Notes are issued, CMS Energy is permitted to pay as dividends on its common stock an amount not to exceed the total of its net income and any proceeds received from the issuance or sale of common stock as defined in the Indentures and $40 million, provided there exists no event of default under the terms of the Secured Credit Facility or Indentures. The same formula applies to limits available to repurchase or reacquire CMS Energy stock for either the payment of dividends or repurchase of stock. In October 1993, CMS Energy issued an additional 4.6 million shares of common stock at a price of $26 5/8. The net proceeds of $119 million were used to reduce existing debt and for general corporate purposes.\nLong-Term Debt: In October 1992, CMS Energy received proceeds of $130 million and $219 million from the issuance of Series A and Series B Notes, respectively. Interest will accrue and increase the principal to the face value of $172 million for the Series A Notes and $294 million for the Series B Notes through October 1, 1995. After such date, interest will be paid semi-annually commencing April 1, 1996, at a rate of 9.5 percent per annum for the Series A Notes and 9.875 percent per annum for the Series B Notes. In November 1992, CMS Energy entered into a $220 million Secured Credit Facility. As of December 31, 1993, $18 million was outstanding at a weighted average interest rate of 5.7 percent. The Notes and Secured Credit Facility are secured by a pledge of stock of Consumers, Enterprises, and NOMECO. Additionally, under the terms of the Secured Credit Facility, CMS Energy may only have outstanding, at any one time, an aggregate of $130 million of unsecured debt except for debt issued to refinance existing debt. The establishment of the Secured Credit Facility and the proceeds from the Notes, net of underwriting expenses, were used to retire the $410 million one-year secured revolving credit facility.\nCMS Energy filed a shelf registration statement with the SEC in January 1994 covering the issuance of up to $250 million of unsecured debt securities. The net proceeds will be used to reduce the amount of CMS Energy Notes outstanding and for general corporate purposes. The unsecured debt securities may be offered from time to time on terms to be determined at the time of the sale.\nConsumers\nCapital Stock: As of December 31, 1992, Consumers effected a quasi- reorganization, an elective accounting procedure in which Consumers' accumulated deficit of $574 million was eliminated against other paid-in capital. This action had no effect on CMS Energy's consolidated financial statements. As a result of the quasi-reorganization and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends in 1993 and also declared from 1993 earnings a $16 million common stock dividend in January 1994. Consumers has authorization from the MPSC and is proceeding to issue $200 million of preferred stock in 1994.\nFirst Mortgage Bonds: Consumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, Articles and the need for regulatory approvals in compliance with appropriate state and federal law. In September 1993, Consumers issued, with MPSC approval, $300 million of 6 3/8 percent first mortgage bonds, due 2003 and $300 million of 7 3/8 percent first mortgage bonds, due 2023. Consumers used the net proceeds from the bond issuance to refund approximately $515 million of higher interest first mortgage bonds and the balance to reduce short-term borrowings. Unamortized debt costs, premiums and discounts and call premiums on the refunded debt totaling approximately $18 million were deferred under SFAS 71, and are being amortized over the lives of the new debt.\nIn February 1994, Consumers issued a call for redemption totaling approximately $10 million. Consumers also fully redeemed two issues of first mortgage bonds totaling approximately $91 million. These redemptions completed Consumers' commitment to the MPSC, under the 1993 authorization to issue first mortgage bonds, to refinance certain long- term debt.\nLong-Term Bank Debt: Under its long-term credit agreement at December 31, 1993, Consumers was required to make 10 remaining quarterly principal payments of approximately $47 million. As of December 31, 1993, the outstanding balance under this credit agreement totaled $469 million with a weighted average interest rate of 4.0 percent. In January 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on the latest maturing $250 million of the then remaining $500 million obligation under its long-term credit agreement.\nOther: Consumers has a total of $131 million of PCRBs outstanding with a weighted average interest rate of 4.2 percent as of December 31, 1993. Consumers classifies $101 million of PCRBs as long-term because it can refinance these amounts through irrevocable letters of credit expiring after one year.\nIn June 1993, Consumers entered into loan agreements in connection with the issuance of approximately $28 million of adjustable rate demand limited obligation refunding revenue bonds, due 2010, which are secured by an irrevocable letter of credit expiring in 1996. These bonds bear an initial interest rate of 2.65 percent. Consumers also entered into loan agreements in connection with the issuance of $30 million of 5.8 percent limited obligation refunding revenue bonds, due 2010, secured by a financial guaranty insurance policy and certain first mortgage bonds of Consumers. Proceeds of these issues were used to redeem on August 1, 1993 in advance of their maturities, approximately $58 million of outstanding PCRBs.\nNOMECO\nAs of December 31, 1993, NOMECO had total debt outstanding of $122 million. Senior serial notes amounting to $45 million with a weighted average interest rate of 9.4 percent are outstanding from a private placement. In November 1993, NOMECO amended the terms of its revolving credit agreement and increased the amount to $110 million. At December 31, 1993, $72 million was outstanding at a weighted average interest rate of 4.7 percent. NOMECO also has $5 million outstanding under other credit agreements.\nEnterprises\nAs of December 31, 1993, MOAPA had $22 million of Clark County, Nevada, tax-exempt bonds outstanding with an interest rate of 3.35%. These bonds are backed by a letter of credit guaranteed by CMS Energy. If the letter of credit is not extended past its current expiration date of June 1, 1994, the bonds could be redeemed with the funds held in a trust account. These funds are invested in certificates of deposits and included in other noncurrent assets. The bonds were issued in 1990 for the purpose of providing partial funding for the development of a tires-to-energy solid waste disposal and resource recovery facility. In December 1993, the Nevada Public Service Commission rejected the power purchase agreement between MOAPA and the Nevada Power Company and subsequently rejected MOAPA's motion for rehearing.\n8: Financial Instruments\nCash, short-term investments and current liabilities approximate their fair value due to the short-term nature of those instruments. The estimated fair value of long-term investments is based on quoted market prices where available. When specific market prices do not exist for an instrument, the fair value is based on quoted market prices of similar investments or other valuation techniques. All long-term investments in financial instruments approximate fair value. The carrying amount of long-term debt was $2.4 billion and $2.7 billion and the fair value of long-term debt was $2.6 billion and $2.8 million as of December 31, 1993 and 1992, respectively. Although the current fair value of the long-term debt, which is based on calculations made by debt pricing specialists, may be greater than the current carrying amount, settlement of the reported debt is generally not expected until maturity. The fair value of CMS Energy's off-balance sheet financial instruments is based on the amount estimated to terminate or settle the obligation. The fair value of interest rate swap agreements was $6 million and $1 million and guarantees/letters of credit was $96 million and $56 million as of December 31, 1993 and 1992, respectively (see Notes 7 and 12).\nOn January 1, 1994, CMS Energy adopted SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, requiring accounting for investments in debt securities to be held to maturity at amortized cost; otherwise debt and marketable equity securities would be recorded at fair value, with any unrealized gains or losses included in earnings if the security is held for trading purposes or as a separate component of shareholders' equity if the security is available for sale. The implementation of this standard did not materially impact CMS Energy's financial position or results of operations.\nIn May 1993, the FASB issued SFAS 114, Accounting by Creditors for Impairment of a Loan, effective in 1995, requiring certain loans that are determined to be impaired be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of any collateral for a secured loan. CMS Energy does not believe this standard will have a material impact on its financial position or results of operations.\n9: Executive Incentive Compensation\nUnder CMS Energy's Performance Incentive Stock Plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. The plan reserves for award not more than 2 percent of CMS Energy's common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. As of December 31, 1993, awards of up to 447,686 shares of common stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Performance criteria were added in 1990 based on CMS Energy's total return to shareholders. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, remains in effect until all authorized options are granted or September 25, 1995. As of December 31, 1993, options for 43,000 shares remained to be granted.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted under the Performance Incentive Stock Plan and options granted under both plans follows:\nRestricted Stock Options ---------- ---------------------------- Number Number Price of Shares of Shares per Share ----------- --------- --------------- Outstanding at January 1, 1991 212,500 1,162,216 $ 7.13 - $34.25 Granted 97,000 194,000 $ 21.13 - $21.13 Exercised or Issued (34,437) (65,125) $ 7.13 - $16.00 --------- ---------- --------------- Outstanding at December 31, 1991 275,063 1,291,091 $ 7.13 - $34.25 Granted 101,000 215,000 $ 17.13 - $18.00 Exercised or Issued (37,422) (21,000) $ 13.00 - $16.00 Canceled (15,375) (50,000) $ 20.50 - $33.88 --------- ---------- --------------- Outstanding at December 31, 1992 323,266 1,435,091 $ 7.13 - $34.25 Granted 132,000 249,000 $ 25.13 - $26.25 Exercised or Issued (54,938) (152,125) $ 7.13 - $21.13 Canceled (84,141) (33,000) $ 20.50 - $33.88 --------- ---------- ---------------\nOutstanding at December 31, 1993 316,187 1,498,966 $ 7.13 - $34.25 ========= ========== ===============\n10: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions\nCMS Energy and its subsidiaries adopted SFAS 106 effective as of the beginning of 1992. The standard required CMS Energy to change its accounting for the cost of health care and life insurance benefits that are provided to retirees from a pay-as-you-go (cash) method to a full accrual method. CMS Energy's non-utility subsidiaries expensed their accumulated transition obligation liability. The amount of such transition obligation is not material to the presentation of the consolidated financial statements or significant to CMS Energy's total transition obligation. Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates.\nBoth the MPSC and FERC have generally adopted SFAS 106 costs for ratemaking purposes provided costs recovered through rates are placed in external funds until they are needed to pay benefits. The MPSC's generic order allows utilities three years to seek recovery of costs and provides for recovery from customers of any deferred costs incurred prior to the beginning of rate recovery of such costs. Consumers anticipates recovering its regulatory asset within 20 years. As discussed in Note 4, Consumers has requested recovery of the portion of these costs allocated to the electric business. In late 1994, Consumers plans to request recovery of the gas utility portion of these costs. CMS Energy plans to fund the benefits using external Voluntary Employee Beneficiary Associations. Funding of the health care benefits would begin when Consumers' rate recovery based on SFAS 106 begins. A portion of the life insurance benefits have previously been funded.\nAs of December 31, 1993, the actuary assumed that retiree health care costs increased 10.5 percent in 1994, then decreased gradually to 5.5 percent in 2000 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $75 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1993 by $9 million.\nFor the years ended December 31, 1993 and 1992, the weighted average discount rate was 7.25 percent and 8 percent, respectively, and the expected long-term rate of return on plan assets was 8.5 percent. Net periodic postretirement benefit cost for health care benefits and life insurance benefits was $51 million in 1993 and $50 million in 1992. The 1993 and 1992 cost was comprised of $13 million and $11 million for service plus $38 million and $39 million for interest, respectively.\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1993 1992 ------- ------- Actuarial present value of estimated benefits Retirees $ 282 $ 265 Eligible for retirement 54 50 Active (upon retirement) 190 177 ------- ------- Accumulated postretirement benefit obligation 526 492 Plan assets (premium deposit fund) at fair value 4 4 ------- ------- Projected postretirement benefit obligation in excess of plan assets (522) (488) Unrecognized prior service cost (39) (39) Unrecognized net loss 41 33 ------- ------- Recorded liability $(520) $(494) ======= =======\nCMS Energy's postretirement health care plan is unfunded; the accumulated postretirement benefit obligation for that plan is $514 million and $482 million at December 31, 1993 and 1992, respectively. Consumers' regulatory asset is $510 million and $485 million at December 31, 1993 and 1992, respectively.\nSupplemental Executive Retirement Plan\nCertain management employees qualify under the SERP. Benefits are based on the employee's service and earnings as defined in the SERP. In 1988, a trust from which SERP benefits are paid was established and funded. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in Consumers' consolidated assets. As of December 31, 1993 and 1992, trust assets at cost (which approximates market) were $18 million and $16 million, respectively, and were classified as other non-current assets.\nDefined Benefit Pension Plan\nA trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan is fully funded, no contributions were made for plan years 1991 through 1993.\nYears Ended December 31 1993 1992 1991 - ----------------------- ----- ----- ----- Discount rate 7.25% 8.5% 8.5% Rate of compensation increase 4.5% 5.5% 5.5% Expected long-term rate of return on assets 8.75% 8.75% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Service cost $ 19 $ 19 $ 18 Interest cost 50 48 48 Actual return on plan assets (92) (36) (88) Net amortization and deferral 34 (20) 29 ------ ------ ------ Net periodic pension cost $ 11 $ 11 $ 7 ====== ====== ======\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP -------------- ------------- 1993 1992 1993 1992 ----- ----- ----- -----\nActuarial present value of estimated benefits Vested $ 471 $ 349 $ 16 $ 11 Non-vested 56 49 - - ----- ----- ----- ----- Accumulated benefit obligation 527 398 16 11 Provision for future pay increases 138 177 8 6 ----- ----- ----- ----- Projected benefit obligation 665 575 24 17 Plan assets (primarily stocks and bonds, including $87 in 1993 and $64 in 1992 in common stock of CMS Energy) at fair value 692 631 - - ----- ----- ----- ----- Projected benefit obligation less than (in excess of) plan assets 27 56 (24) (17) Unrecognized net (gain) loss from experience different than assumed (56) (76) 7 2 Unrecognized prior service cost 45 49 1 1 Unrecognized net transition (asset) obligation (44) (49) 1 1 Adjustment to recognize minimum liability - - (1) - ----- ----- ----- ----- Recorded liability $ (28) $ (20) $ (16) $ (13) ====== ====== ====== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\nIn 1991, certain eligible employees accepted early retirement incentives. The incentives consisted of lump-sum cash payments and increased pension payments. The pretax cost of the incentives was $25 million. Also in 1991, portions of the projected benefit obligation were settled which resulted in a pretax gain of $25 million that offset the early retirement costs.\n11: Leases\nCMS Energy, Consumers, and Enterprises lease various assets, including vehicles, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement was extended an additional year and is now scheduled to expire in November 1995. The maximum amount of nuclear fuel that can be leased increased from $55 million to $70 million. Consumers further increased this amount in early 1994 to $80 million. The lease provides for an additional one-year extension upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $57 million as of December 31, 1993. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under CMS Energy's non-cancelable leases at December 31, 1993, were:\nIn Millions Capital Operating Leases Leases ------- --------- 1994 $ 43 $ 9 1995 64 8 1996 16 3 1997 15 3 1998 13 3 1999 and thereafter 26 22 ----- ----- Total minimum lease payments 177 $ 48 ===== Less imputed interest 27 ----- Present value of net minimum lease payments 150 Less current portion 35 ----- Non-current portion (a) $115 =====\n(a) In January 1994, Consumers amended its nuclear fuel lease to include fuel previously owned at Big Rock Point. This is estimated to increase the non-current portion of capital leases by approximately $6 million. Consumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1993, 1992 and 1991, were $18 million, $15 million and $15 million, respectively.\nCapital lease expenses for the years ended December 31, 1993, 1992 and 1991 were $34 million, $47 million and $51 million, respectively. Included in these amounts for the years ended 1993, 1992 and 1991, are nuclear fuel lease expenses of $13 million, $17 million and $24 million, respectively.\n12: Commitments, Contingencies and Other\nLudington Pumped Storage Plant Litigation\nIn 1986, the Attorney General filed a lawsuit on behalf of the State of Michigan in the Circuit Court of Ingham County, seeking damages from Consumers and Detroit Edison for alleged injuries to fishery resources because of the operation of the Ludington Pumped Storage Plant. The state sought $148 million (including $16 million of interest) for past injuries and $89,000 per day for future injuries, with the latter amount to be adjusted upon installation of \"adequate\" fish barriers and other changed conditions.\nIn 1987, the Attorney General filed a second lawsuit alleging that Consumers and Detroit Edison have breached a bottomlands lease agreement with the state and asked that the lease be declared void. This complaint was consolidated with the suit described in the preceding paragraph. In 1990, both of the lawsuits were dismissed on the basis of federal preemption. In 1993, the Court of Appeals overturned the dismissal, as to damages, effectively allowing the state to continue its damages lawsuit against Consumers and Detroit Edison, but generally affirmed the lower court's ruling as to the breach of lease claim. The Court of Appeals' ruling also limited any potential damages to those occurring no earlier than 1983. Consumers, Detroit Edison and the Attorney General have filed an application for leave to appeal with the Michigan Supreme Court. Consumers and Detroit Edison are seeking to have the trial court's dismissal of the damages claim affirmed.\nEach year since 1989, Consumers and Detroit Edison have complied with FERC orders by installing a seasonal barrier net from April to October at the Ludington plant site. The FERC is now considering whether the barrier net (along with other actions by Consumers, including contributions to state fish-stocking programs) would be a satisfactory permanent solution.\nEnvironmental Matters\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers and CMS Energy believe that it is unlikely that their liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on their financial positions or results of operations.\nThe State of Michigan in 1990 passed amendments to the Environmental Response Act that established a state program similar to the federal Superfund law, though broader in scope. Under this law, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation/feasibility studies for three of these sites. Work plans for remedial investigation/feasibility studies for four other sites have also been prepared. The purpose of a remedial investigation/feasibility study is to define the nature and extent of contamination at a site and to determine which of several possible remedial action alternatives, including no action, may be required under the Environmental Response Act. The DNR has approved two of the three plans for remedial investigation/feasibility studies submitted and is currently reviewing the one remaining. The cost to conduct one of the approved studies will be approximately $250,000 based on bids received. Although the actual cost of conducting the remaining two remedial investigation/feasibility studies will not be known until bids are received from contractors, Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study. Based on Consumers' knowledge of other utility remedial actions, remediation costs for Consumers for these sites may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. The MPSC stated the length of the period may be reviewed from time to time, but any revisions would be prospective. Consumers and CMS Energy believe costs incurred for both investigation and any required remedial actions would be recoverable from utility customers under established regulatory policies and accordingly are not likely to materially affect their financial positions or results of operations.\nIncluded in the 1990 amendments to the federal Clean Air Act are provisions that limit emissions of sulfur dioxide and nitrogen oxides and require enhanced emissions monitoring. All of Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in 2000. Beginning in 1995, certain coal-fueled generating units will receive emissions allowances (all of Consumers' coal units will receive allowances beginning in 2000). Based on projected emissions from these units, Consumers expects to have excess allowances which may be sold or saved for future use.\nThe Clean Air Act's provisions require Consumers to make capital expenditures estimated to total $74 million through 1999 for completed, in-process and possible modifications at coal-fired units based on existing and proposed regulations. Management believes that Consumers' annual operating costs will not be materially affected.\nThe EPA has asked a number of utilities in the Great Lakes area to voluntarily retire certain equipment containing specific levels of polychlorinated biphenyls. Consumers believes that it is largely in compliance with the EPA's petition. Consumers is continuing to study the request and has been granted an extension for responding until March 30, 1994.\nCapital Expenditures\nCMS Energy estimates capital expenditures, including investments in unconsolidated subsidiaries, DSM and new lease commitments, of $792 million for 1994, $690 million for 1995 and $714 million for 1996.\nPublic Utility Holding Company Act Exemption\nCMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. In 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nOther\nAs of December 31, 1993, CMS Energy and Enterprises have guaranteed up to $90 million in contingent obligations of unconsolidated affiliates of Enterprises' subsidiaries.\nNOMECO has hedged its gas supply obligations in the years 2001 through 2006 by purchasing the economic equivalent of 10,000 MMBtu per day at a fixed, escalated price starting at $2.82 per MMBtu in 2001. The settlement periods are each a one-year period ending December 31, 2001 through 2006 on 3.65 MMBtu. If the \"floating price,\" essentially the then current Gulf Coast spot price, for a period is higher than the \"fixed price,\" the seller pays NOMECO the difference, and vice versa. If a party's exposure at any time exceeds $2 million, that party is required to obtain a letter of credit in favor of the other party for the excess over $2 million, to a maximum of $10 million. At December 31, 1993, the seller had arranged a letter of credit in NOMECO's favor for $10 million. NOMECO also periodically enters into oil and gas price hedging arrangements to mitigate its exposure to price fluctuations on the sale of crude oil and natural gas. As of December 31, 1993, the fair value of these hedge arrangements was not material.\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment, can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. A complaint seeking certification as a class action suit was filed against Consumers in a local county circuit court in 1993. The complaint alleges the existence of a purported class that has incurred damages of up to $1 billion, primarily to certain livestock owned by the purported class, as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and intends to vigorously oppose the certification of the class and this suit.\nIn addition to the matters disclosed in these notes, Consumers and certain other subsidiaries of CMS Energy are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nThe ultimate effect of the proceedings discussed in this note is not expected to have a material impact on CMS Energy's financial position or results of operations.\n13: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1993 1992 - ----------- ---- ---- Net investment Ludington - 51% $114 $112 Campbell Unit 3 - 93.3% 349 360 Transmission lines - various 32 33\nAccumulated depreciation Ludington $ 74 $ 71 Campbell Unit 3 210 199 Transmission lines 11 10\n14: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1993 1992 1991 ------ ------ ------ Cash transactions Interest paid (net of amounts capitalized) $193 $203 $325 Income taxes paid (net of refunds) 32 19 21\nNon-cash transactions Nuclear fuel placed under capital lease $ 28 $ 30 $ 6 Other assets placed under capital leases 30 39 21 Capital leases refinanced 42 - - Assumption of debt - 15 -\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1993 1992 1991 ------ ------ ------ Sale of receivables, net $ 60 $ 25 $ - Accounts receivable 22 6 118 Accrued revenue (48) 88 7 Accrued refunds (48) (143) 102 Inventories (32) 23 (8) Accounts payable (31) 20 (70) Tax Reform Act refund reserve - - (77) Other current assets and liabilities, net (19) 46 (20) Non-current deferred amounts, net 9 (28) 108 ------ ------ ------ $ (87) $ 37 $ 160 ======= ====== ======\n15: Reportable Segments\nCMS Energy operates principally in the following five business segments: electric utility, gas utility, oil and gas exploration and production, independent power production, and gas transmission and marketing.\nThe Consolidated Statements of Income show operating revenue and pretax operating income by business segment. Other segment information follows:\nIn Millions Years Ended December 31 1993 1992 1991 --------- -------- ------ Depreciation, depletion and amortization Electric utility $ 241 $ 230 $ 172 Gas utility 73 76 70 Oil and gas exploration and production 45 38 33 Independent power production 2 2 2 Gas transmission and marketing 1 1 - Other 3 1 6 -------- ------- -------- $ 365 $ 348 $ 283 ======== ======= ========\nIdentifiable assets Electric utility (a) $ 4,027 $3,812 $3,399 Gas utility 1,443 1,387 1,186 Oil and gas exploration and production 398 364 334 Independent power production 488 333 321 Gas transmission and marketing 75 60 45 Other 533 892 909 --------- ------- ------- $ 6,964 $6,848 $6,194 ========= ======= =======\nCapital expenditures (b)(c)(d) Electric utility (e) $ 365 $ 353 $ 213 Gas utility 127 86 61 Oil and gas exploration and production 81 68 71 Independent power production 110 12 18 Gas transmission and marketing 14 6 17 Other 69 69 33 --------- ------- ------- $ 766 $ 594 $ 413 ========= ======= =======\n(a) Includes abandoned Midland investment of $162 million, $175 million and $287 million for 1993, 1992 and 1991, respectively.\n(b) Includes capital leases for nuclear fuel and other assets (see Note 14).\n(c) Includes equity investments in unconsolidated partnerships of $108 million for 1993, $12 million for 1992 and $33 million for 1991.\n(d) Certain prior year amounts have been adjusted for comparative purposes.\n(e) Includes DSM costs of $52 million for 1993 and $26 million for 1992.\n16: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1993 obligation to purchase electricity from the MCV Partnership was approximately 14 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership is shown below:\nStatements of Income In Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Operating revenue (a) $ 548 $ 488 $ 425 Operating expenses 362 315 278 ------ ------ ------ Operating income 186 173 147 Other expense, net (189) (190) (186) ------ ------ ------ Net loss $ (3) $ (17) $ (39) ====== ====== ======\nBalance Sheets In Millions December 31 1993 1992 - ----------- ------ ------ Assets Current assets (a) $ 181 $ 165 Property, plant and equipment, net 2,073 2,124 Other assets 146 147 ------ ------ $2,400 $2,436 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 198 $ 189 Long-term debt and other non-current liabilities (b) 2,147 2,189 Partners' equity (c) 55 58 ------ ------ $2,400 $2,436 ====== ======\n(a) Revenue from Consumers totaled $505 million, $444 million and $384 million for 1993, 1992 and 1991, respectively. As of December 31, 1993, 1992 and 1991, $44 million, $38 million and $33 million, respectively, were receivable from Consumers.\n(b) FMLP is a beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP (see Note 3). At December 31, 1993 and 1992, lease obligations of $1.7 billion were owed to the owner trust of which FMLP is the sole beneficiary. CMS Holdings' share of the interest and principal portion for the 1993 lease payments was $63 million and $16 million, respectively, and for the 1992 lease payments was $65 million and $12 million, respectively. The lease payments service $1.2 billion and $1.3 billion in non-recourse debt outstanding as of December 31, 1993 and 1992, respectively, of the owner-trust whose beneficiary is FMLP. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1993 and 1992, the owner-trust whose beneficiary is FMLP made debt payments of $172 million and $166 million, respectively, which included $10 million and $8 million principal and $25 million and $26 million interest, respectively, on the MCV Bonds held by MEC Development Corporation during part of 1991 and by Consumers through December 1993.\n(c) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of long-term debt and preferred stock of CMS ENERGY CORPORATION (a Michigan corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, common stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CMS Energy Corporation and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes. Additionally, as discussed in Note 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\n(This page intentionally left blank)\nConsumers Power Company\n1993 Financial Statements\n(This page intentionally left blank)\nConsumers Power Company Management's Discussion and Analysis\nConsumers is a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry.\nConsolidated 1993 Earnings\nConsolidated net income after dividends on preferred stock totaled $187 million in 1993, compared to net losses of $255 million in 1992 and $260 million in 1991. The increased net income reflects the Settlement Order related to power purchases from the MCV Partnership. Earnings also reflect record setting electric sales and gas deliveries.\nCash Position, Financing and Investing\nConsumers' operating cash requirements are met by its operating and financing activities. In 1993 and 1992, Consumers' cash from operations mainly resulted from its sale and transportation of natural gas and its sale and transmission of electricity. Cash from operations for 1993 primarily reflects record-setting electric sales and gas deliveries and reduced after-tax cash shortfalls resulting from Consumers' purchases of power from the MCV Partnership.\nDuring 1992, Consumers' cash from operations increased as compared to 1991 primarily due to lower interest charges resulting from reduced levels of debt, partially offset by higher operating expenditures and reduced electric rates. In 1991, Consumers generated cash primarily from its consolidated operating and investing activities, including $859 million of net proceeds from the sale of a majority of the MCV Bonds.\nOver the last three years, Consumers has used its cash primarily to fund its extensive construction expenditures and to improve the reliability of its transmission and distribution systems. Consumers has also used its cash to retire portions of long-term debt and to pay cash dividends.\nFinancing Activities\nAs a result of the 1992 quasi-reorganization (see Note 7 to the Consolidated Financial Statements), and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends during 1993 and declared a $16 million common stock dividend in January 1994 from 1993 earnings.\nDuring 1993, Consumers significantly reduced its future interest charges by retiring approximately $51 million of high-cost outstanding debt and refinancing approximately $573 million of other debt at lower interest rates. For further information, see Note 7.\nInvesting Activities\nCapital expenditures (excluding assets placed under capital leases of $58 million) and deferred demand-side management costs totaled $503 million in 1993 as compared to $437 million in 1992. These amounts primarily represent capital investments in Consumers' electric and gas utility segments. In December 1993, Consumers sold $309 million of MCV Bonds it held and used the net proceeds to temporarily reduce short-term borrowings and ultimately plans to reduce long-term debt and to finance its construction program.\nOutlook\nConsumers estimates that capital expenditures, including demand-side management and new lease commitments, related to its electric and gas utility operations will total approximately $1.5 billion over the next three years. In Millions Years Ended December 31 1994 1995 1996 ---- ---- ----\nConsumers Construction (including DSM) $474 $425 $391 Nuclear fuel lease 46 4 45 Capital leases other than nuclear fuel 27 27 28 Michigan Gas Storage 6 5 7 ---- ---- ---- $553 $461 $471 ==== ==== ====\nConsumers is required to redeem or retire approximately $741 million of long-term debt during 1994 through 1996. Cash generated by operations is expected to satisfy a substantial portion of these capital expenditures and debt retirements.\nConsumers has several other available sources of credit including unsecured, committed lines of credit totaling $165 million and a $470 million working capital facility. Consumers has FERC authorization to issue or guarantee up to $900 million in short-term debt through December 31, 1994. Consumers uses short-term borrowings to finance working capital, seasonal fuel inventory and to pay for capital expenditures between long-term financings. Consumers has an agreement permitting the sales of certain accounts receivable for up to $500 million. As of December 31, 1993 and 1992, receivables sold totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\nIn October 1993, Consumers received MPSC authorization and is proceeding to issue $200 million of preferred stock in 1994. In February 1994, Consumers called or redeemed approximately $101 million of first mortgage bonds.\nAt December 31, 1993, Consumers' capital structure consisted of approximately 32 percent common equity, 4 percent preferred stock, and 64 percent long- and short-term debt (including capital leases and notes payable). Consumers' long term goal is to achieve and maintain a capital structure consisting of approximately 37 percent common equity, 8 percent preferred stock and 55 percent debt. Management expects to achieve this structure through debt reductions, accumulated earnings, the issuance of new preferred stock and equity investments from CMS Energy.\nElectric Utility Operations\nComparative Results of Operations\nElectric Pretax Operating Income: The improvement in 1993 pretax operating income compared to 1992 reflects an increase of $126 million relating to the resolution of the recoverability of MCV power purchase costs under the PPA and increased electric system sales of $45 million, partially offset by higher costs to improve system reliability. The 1992 decrease of $66 million from the 1991 level primarily resulted from an increased emphasis on system reliability improvements and decreased electric rates resulting from the full-year impact of a mid-1991 rate decrease.\nIn Millions 1993 1992 Over Over (Under) (Under) 1992 1991 ------ ------\nSales growth $ 34 $ 11 Weather 11 (16) Resolution of MCV power cost issues 126 - Other regulatory issues 5 (13) O&M, general taxes and depreciation (a) (44) (48) ----- ----- Total change $132 $(66) ===== =====\n(a) Largely caused by Consumers' system reliability improvement program.\nElectric Sales: Electric system sales in 1993 totaled a record 31.7 billion kWh, a 3.8 percent increase from 1992 levels. In 1993, residential and commercial sales increased 3.4 percent and 3.0 percent, respectively, while industrial sales increased 6.5 percent. Growth in the industrial sector was the strongest in the auto-related segments of fabricated and primary metals and transportation equipment. Electric system sales in 1992 totaled 30.5 billion kWh, essentially unchanged from the 1991 levels.\nElectric Sales Millions of kWh 1993 1992 1991 ------ ------ ------\nResidential 10,066 9,733 9,997 Commercial 8,909 8,652 8,692 Industrial 11,541 10,831 10,692 Sales for resale 1,142 1,292 1,311 ------ ------ ------ System sales (a) 31,658 30,508 30,692 ====== ====== ======\nTotal customers (000) 1,526 1,506 1,492 ====== ====== ======\n(a) Excludes intersystem exchanges of power with other utilities through joint dispatching for the economic benefit of customers. The level of intersystem sales has been essentially unchanged during each of the last three years.\nPower Costs: Power costs for 1993 totaled $908 million, a $31 million increase from the corresponding 1992 period. This increase primarily reflects greater power purchases from outside sources to meet increased sales demand and to supplement decreased generation at Palisades due to an extended outage. Power costs for 1992 totaled $877 million, a $17 million decrease as compared to 1991.\nOperation and Maintenance: Increases in other operation and maintenance expense for 1993 and 1992 reflected increased expenditures to improve electric system reliability.\nDepreciation: The increased depreciation for 1993 reflects additional capital investments in plant. The 1992 increase resulted from higher depreciation rates, increased amortization of abandoned nuclear investment and increased nuclear plant decommissioning expense.\nElectric Utility Rates\nPower Purchases from the MCV Partnership: Consumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1993 1994 thereafter - ---- ----- ----- ---------- MW 1,023 1,132 1,240\nSince 1990, recovering capacity and fixed-energy costs for power purchased from the MCV Partnership has been a significant issue. Effective January 1, 1993, the Settlement Order allowed Consumers to recover from electric retail customers substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership, significantly reducing the amount of future underrecoveries for these power costs. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nPrior to the Settlement Order, Consumers had recorded losses for underrecoveries from 1990 through 1992. In December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order, based on management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. The after-tax expense for the time value of money for the $343 million loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. If Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Estimates for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. As of December 31, 1993, these amounts total $26 million. Although Consumers intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action. For further information regarding power purchases from the MCV Partnership, see Note 3.\nPSCR Matters: Consumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage and any associated delays. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies.\nElectric Rate Case: Consumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. In March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported a performance incentive which Consumers also supported. For further information, see Note 4.\nElectric Conservation Efforts\nIn October 1993, Consumers completed the customer participation portion of several incentive-based demand-side management programs which were designed to encourage the efficient use of energy, primarily through conservation measures. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on electric common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent, for one year following reconciliation hearings with the MPSC. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives. For further information, see Note 4.\nElectric Capital Expenditures\nConsumers estimates capital expenditures, including demand-side management and new lease commitments, related to its electric utility operations of $396 million for 1994, $324 million for 1995 and $332 million for 1996.\nElectric Environmental Matters and Health Concerns\nThe 1990 amendment of the federal Clean Air Act significantly increased the environmental constraints that utilities will operate under in the future. While the Clean Air Act's provisions will require Consumers to make certain capital expenditures in order to comply with the amendments for nitrogen oxide reductions, Consumers' generating units are presently operating at or near the sulfur dioxide emission limits which will be effective in the year 2000. Therefore, management believes that Consumers' annual operating costs will not be materially affected.\nIn 1990, the State of Michigan passed amendments to the Environmental Response Act, under which Consumers expects that it will ultimately incur costs at a number of sites, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from its electric customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers believes that it is unlikely that its liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position or results of operations.\nElectric Outlook\nConsumers expects economic growth, competitive rates and other factors to increase the demand for electricity within its service territory by approximately 1.8 percent per year over the next five years. For the near term, Consumers currently plans a reserve margin of 20 percent and expects to fill the additional capacity required through long- and short-term power purchases. Long-term purchased power will likely be obtained through a competitive bidding solicitation process utilizing the framework established by the MPSC in 1992. Capacity from the MCV Facility above the levels authorized by the MPSC may be offered by Consumers in connection with the solicitation.\nA recent NRC review of Consumers' performance at Palisades showed a decline in performance. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. To provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management which is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nConsumers is currently collecting $45 million annually from electric retail customers for the future decommissioning of its two nuclear plants. Consumers believes these amounts will be adequate to meet current decommissioning cost estimates. For further information regarding nuclear decommissioning, see Note 2.\nConsumers' on-site storage pool at Palisades is at capacity, and it is unlikely that the DOE will begin accepting any spent nuclear fuel by the originally scheduled date in 1998. Consumers is using NRC-approved dry casks, which are steel and concrete vaults, for temporary storage. Several appeals relating to NRC approval of the casks are now pending at the U.S. Sixth Circuit Court of Appeals. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers has experienced an increase in complaints in 1993 relating primarily to the effect of so-called stray voltage on certain livestock. A complaint seeking certification as a class action suit has been filed against Consumers alleging significant damages, primarily related to certain livestock, which Consumers believes to be without merit (see Note 12).\nSome of Consumers' larger industrial customers are exploring the possibility of constructing and operating their own on-site generating facilities. Consumers is actively working with these customers to develop rate and service alternatives that are competitive with self-generation options. Although Consumers' electric rates are competitive with other regional utilities, Consumers has on file with the FERC two open access interconnection tariffs which could have the effect of increasing competition for wholesale customers. As part of its current electric rate case, Consumers has requested that the MPSC reduce the level of rate subsidization of residential customers by commercial and industrial customers so as to further improve rate competitiveness for its largest customers.\nThe MPSC has completed a hearing on a proposal by ABATE to create an experimental retail wheeling tariff. Certain other parties have proposals in support of retail wheeling under development. In August 1993, an ALJ recommended that the MPSC reject the proposed experiment. An MPSC order is expected early in 1994.\nGas Utility Operations\nComparative Results of Operations\nGas Pretax Operating Income: For 1993, pretax operating income increased $37 million compared to 1992, reflecting higher gas deliveries (both sales and transportation volumes) and more favorable regulatory recovery of gas costs related to transportation. During 1992, gas pretax operating income increased $45 million from the 1991 level, essentially for many of the same reasons as the current period.\nIn Millions 1993 1992 Over Over (Under) (Under) 1992 1991 ------ ------\nSales growth $ 7 $ 14 Weather 10 6 Regulatory recovery of gas cost 12 48 O&M, general taxes and depreciation 8 (23) ------ ------ Total change $ 37 $ 45 ====== ======\nGas Deliveries: Gas sales and gas transported in 1993 totaled 410.6 bcf, a 6.9 percent increase from 1992. In 1992, gas sales and gas transported totaled 384.1 bcf, a 6.1 percent increase from 1991 deliveries.\nGas Deliveries Bcf 1993 1992 1991 ----- ----- -----\nResidential 174.9 166.7 157.2 Commercial 55.9 53.4 50.2 Industrial 13.9 13.5 14.5 Other .2 .2 .2 ----- ----- ----- Gas sales 244.9 233.8 222.1 Transportation deliveries 70.5 66.4 61.5 Transportation for MCV 73.4 63.5 55.0 Off-system transportation service 21.8 20.4 23.4 ----- ----- ----- Total deliveries 410.6 384.1 362.0 ===== ===== =====\nTotal customers (000) 1,423 1,402 1,382 ===== ===== =====\nGas Utility Rates\nConsumers currently plans to file a request in 1994 with the MPSC to increase its gas rates. The request would include, among other things, costs for postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. A final order should be received approximately nine to twelve months after the request is filed.\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. The Trunkline contract covers gas deliveries through October 1994 and is at a price reduced in September 1993. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims.\nIn 1992, the FERC issued Order 636, which makes a number of significant changes to the structure of the services provided by interstate natural gas pipelines to be implemented by the 1993-94 winter heating season. Consumers is a significant purchaser of gas from an interstate pipeline (Trunkline) and is a major transportation customer of a number of pipelines. Management believes that Consumers will recover any transition costs it may incur and such restructuring will not have a significant impact on its financial position or results of operations.\nIn July 1993, Michigan Gas Storage submitted a notice of rate change with the FERC to revise its operation and maintenance expenses for 1993 and update plant costs to reflect the addition of approximately $27 million of new plant additions in 1993 and began collecting the revised rates subject to refund and a hearing in February 1994. Hearings or settlement conferences will follow. For further information regarding gas utility rates, see Note 4.\nGas Capital Expenditures\nConsumers estimates capital expenditures, including new lease commitments, related to its gas utility operations of $99 million for 1994, $88 million for 1995 and $81 million for 1996.\nGas Environmental Matters\nUnder the Environmental Response Act, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation/feasibility studies for three of these sites. Work plans for remedial investigation/feasibility studies for four other sites have also been prepared. The DNR has approved two of the three plans for remedial investigation/feasibility studies submitted and is currently reviewing the one remaining. Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study, which may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from gas utility customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nGas Outlook\nIn 1993, Consumers purchased approximately 85 percent of its required gas supply under long-term contracts, and the balance on the spot market. Trunkline supplied approximately 41 percent of the total requirement. Consumers expects gas supply reliability to be ensured through long-term supply contracts, with purchases in the short-term spot market when economically beneficial. Management believes that Consumers' ability to purchase gas during the off-season and store it in its extensive underground storage facilities will continue to help provide customers with low-cost, competitive gas rates.\nConsumers anticipates growth in gas deliveries of approximately 0.6 percent per year over the next five years. Management believes that environmental benefits, along with the federal requirements included in the Energy Act, create an opportunity for growth in the natural gas vehicle industry.\nOther\nOther Income: The 1993 other income level reflects lower Midland-related losses than experienced in 1992. The 1992 loss included a $343 million charge related to the Settlement Order. The 1991 loss included $294 million, related to an MPSC order received in 1991 that allowed Consumers to recover only $760 million of remaining abandoned Midland investment, and a $92 million loss related to the cancellation of the CMS Debentures.\nPublic Utility Holding Company Act Exemption: CMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. On April 15, 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nConsumers Power Company Notes to Consolidated Financial Statements\n1: Corporate Structure\nConsumers is a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, and is the principal subsidiary of CMS Energy, an energy holding company. Consumers' customer base includes a mix of residential, commercial and diversified industrial customers, the largest of which is the automotive industry.\n2: Summary of Significant Accounting Policies and Other Matters\nBasis of Presentation\nThe consolidated financial statements include Consumers and its wholly owned subsidiaries. Consumers eliminates all material transactions between its consolidated companies. Consumers uses the equity method of accounting for investments in its companies and partnerships where it has more than a 20 percent but less than a majority ownership interest.\nGas Inventory\nConsumers uses the weighted average cost method for valuing working gas inventory. Cushion gas, which is gas stored to maintain reservoir pressure for recovery of working gas, is recorded in the appropriate gas utility plant account. Consumers stores gas inventory in its underground storage facilities.\nMaintenance, Depreciation and Depletion\nProperty repairs and minor property replacements are charged to maintenance expense. Depreciable property retired or sold plus cost of removal (net of salvage credits) is charged to accumulated depreciation. Consumers bases depreciation provisions for utility plant on straight-line and units-of-production rates approved by the MPSC. In May 1991, the MPSC approved an increase of approximately $15 million annually in Consumers' electric and common utility plant depreciation rates. The composite depreciation rate for electric utility property was 3.4 percent for 1993 and 1992 and 3.3 percent for 1991. The composite rate for gas utility plant was 4.4 percent for 1993 and 4.3 percent for 1992 and 1991. The composite rate for other plant and property was 4.7 percent for 1993, 5.8 percent for 1992 and 3.7 percent for 1991.\nNew Accounting Standards\nIn November 1992, the FASB issued SFAS 112, Employers' Accounting for Postemployment Benefits, which Consumers adopted January 1, 1994. Consumers pays for several postemployment benefits, the most significant being workers compensation. Because Consumers' postemployment benefit plans do not vest or accumulate, the standard did not materially impact Consumers' financial position or results of operations. For new accounting standards related to financial instruments, see Note 8.\nNuclear Fuel, Decommissioning and Other Nuclear Matters\nConsumers amortizes nuclear fuel cost to fuel expense based on the quantity of heat produced for electric generation. Interest on leased nuclear fuel is expensed as incurred. Under federal law, the DOE is responsible for permanent disposal of spent nuclear fuel at costs to be paid by affected utilities under various payment options. However, in a statement released February 17, 1994, the DOE asserted that it does not have a legal obligation to accept spent nuclear fuel without an operational repository. The DOE is exploring options to offset the costs incurred by nuclear utilities in continuing to store spent nuclear fuel on site. For fuel burned after April 6, 1983, Consumers charges disposal costs to nuclear fuel expense, recovers it through electric rates and remits it to the DOE quarterly. Consumers has elected to defer payment for disposal of spent nuclear fuel burned before April 7, 1983 until the spent fuel is delivered to the DOE. As of December 31, 1993, Consumers has recorded a liability to the DOE of $90 million, including interest, to dispose of spent nuclear fuel burned before April 7, 1983. Consumers has been recovering through electric rates the amount of this liability, excluding a portion of interest. Consumers' liability to the DOE becomes due when the DOE takes possession of Consumers' spent nuclear fuel, which was originally scheduled to occur in 1998.\nIn April 1993, the NRC approved the design of the dry spent fuel storage casks now being used by Consumers at Palisades. In May 1993, the Attorney General and certain other parties commenced litigation to block Consumers' use of the storage casks, alleging that the NRC had failed to comply adequately with the National Environmental Policy Act. As of mid-February 1994, the courts have declined to prevent such use and have refused to issue temporary restraining orders or stays. Several appeals relating to this matter are now pending at the U.S. Sixth Circuit Court of Appeals. Consumers loaded two dry storage casks with spent nuclear fuel in 1993 and expects to load additional casks in 1994 prior to Palisades' 1995 refueling. If Consumers is unable to continue to use the casks as planned, significant costs, including replacement power costs during any resulting plant shutdown, could be incurred.\nConsumers currently estimates decommissioning costs (decontamination and dismantlement) of $208 million and $399 million, in 1993 dollars, for the Big Rock Point and Palisades nuclear plants, respectively. At December 31, 1993, Consumers had recorded $171 million of decommissioning costs and classified the obligation as accumulated depreciation. In January 1987, Consumers began collecting estimated costs to decommission its two nuclear plants through a monthly surcharge to electric customers which currently totals $45 million annually. Consumers expects to file updated decommissioning estimates with the MPSC on or before March 31, 1995. Amounts collected from electric retail customers are deposited in trust. Trust earnings are recorded as an investment with a corresponding credit included in accumulated depreciation. The total amount of the trust will be available for decommissioning Big Rock Point and Palisades at the end of their respective license periods in 2000 and 2007. Consumers believes the amounts being collected are adequate to meet its currently estimated decommissioning costs and current NRC requirements.\nIn November 1993, Palisades returned to service following a planned refueling and maintenance outage that had been extended due to several unanticipated repairs. The results of an NRC review of Consumers' performance at Palisades published shortly thereafter showed a decline in performance ratings for the plant. Management believes that an increased emphasis on internal assessments will improve performance at Palisades. In order to provide NRC senior management with a more in-depth assessment of plant performance, the NRC has initiated a diagnostic evaluation team inspection at Palisades. The inspection will be a broad-based evaluation of all aspects of nuclear plant operation and management. The evaluation is expected to commence in March 1994, with results of the evaluation expected to be available in May 1994. The outcome of this evaluation cannot be predicted. Similar reviews conducted at nuclear plants of other utilities in recent years have in some cases resulted in increased regulatory oversight or required actions to improve plant operations, maintenance or condition.\nPlateau Resources Ltd.\nIn August 1993, Consumers sold its ownership interest in Plateau to U. S. Energy Corp. As a result of the sale, approximately $14 million of Plateau's cash and cash equivalents, other assets and liabilities, including certain future decommissioning, environmental and other contingent liabilities were transferred to U. S. Energy Corp. In view of prior write-offs, this transaction did not result in any material gains or additional losses.\nReclassifications\nConsumers and the MCV Partnership (see Note 17) have reclassified certain prior year amounts for comparative purposes. These reclassifications did not affect the net losses for the years presented.\nRevenue and Fuel Costs\nConsumers accrues revenue for electricity and gas used by its customers but not billed at the end of an accounting period. Consumers also accrues or reduces revenue for any underrecovery or overrecovery of electric power supply costs and natural gas costs by establishing a corresponding asset or liability until Consumers bills these unrecovered costs or refunds the excess recoveries to customers after reconciliation hearings conducted before the MPSC.\nUtility Regulation\nConsumers accounts for the effects of regulation under SFAS 71, Accounting for the Effects of Certain Types of Regulation. As a result, the actions of regulators affect when revenues, expenses, assets and liabilities are recognized.\nOther\nFor significant accounting policies regarding cash equivalents, see Note 14; for income taxes, see Note 5; and for pensions and other postretirement benefits, see Note 10.\n3: The Midland Cogeneration Venture\nThe MCV Partnership, which leases and operates the MCV Facility, contracted to supply electricity and steam to The Dow Chemical Company and to sell electricity to Consumers for a 35-year period beginning in March 1990. At December 31, 1993, Consumers, through its subsidiaries, held the following assets related to the MCV: 1) CMS Midland owned a 49 percent general partnership interest in the MCV Partnership; and 2) CMS Holdings held through the FMLP a 35 percent lessor interest in the MCV Facility. In late 1993, Consumers sold its remaining $309 million investment in the MCV Bonds.\nPower Purchases from the MCV Partnership\nConsumers is obligated to purchase the following amounts of contract capacity from the MCV Partnership under the PPA:\n1995 and Year 1991 1992 1993 1994 thereafter - ---- ----- ----- ----- ----- ---------- MW 806 915 1,023 1,132 1,240\nDuring 1992 and 1991, the MPSC only allowed Consumers to recover costs of power purchased from the MCV Partnership based on delivered energy at rates less than Consumers paid for 840 MW in 1992 and 806 MW in 1991. As a result, Consumers recorded after-tax losses of $86 million in 1992 and $124 million in 1991.\nOn March 31, 1993, the MPSC approved, with modifications, the Revised Settlement Proposal which had been co-sponsored by Consumers, the MPSC staff and 10 small power and cogeneration developers. These parties accepted the Settlement Order and the MCV Partnership confirmed that it did not object to its terms. ABATE and the Attorney General have filed claims of appeal of the Settlement Order with the Court of Appeals.\nThe Settlement Order determined the cost of power purchased from the MCV Partnership that Consumers can recover from its electric retail customers and will significantly reduce the amount of future underrecoveries for these power costs. Effective January 1, 1993, the Settlement Order allowed Consumers to recover substantially all of the payments for its ongoing purchase of 915 MW of contract capacity from the MCV Partnership. Capacity and energy purchases from the MCV Partnership above the 915 MW level can be competitively bid into Consumers' next solicitation for power or, if necessary, utilized for current power needs with a prudency review and a pricing recovery determination in annual PSCR cases. In either instance, the MPSC would determine the levels of recovery from customers for the power purchased. The Settlement Order also provides Consumers the right to remarket all of the remaining capacity to third parties.\nThe PPA requires Consumers to pay a minimum levelized average capacity charge of 3.77 cents per kWh, a fixed energy charge and a variable energy charge based primarily on Consumers' average cost of coal consumed. The Settlement Order provided Consumers two options for the recovery that could be used for capacity charges paid to the MCV Partnership. Under the option selected, Consumers is scheduling deliveries of energy from the MCV Partnership whenever it has energy available up to hourly availability limits, or \"caps,\" for the 915 MW of capacity authorized for recovery in the Settlement Order. Consumers can recover an average 3.62 cents per kWh capacity charge and the prescribed energy charges associated with the scheduled deliveries within the caps, whether or not those deliveries are scheduled on an economic basis. Through December 31, 1997, there is no cap applied during on-peak hours to Consumers' recovery for the purchase of capacity made available within the 915 MW authorized. Recovery for purchases during off-peak hours is capped at 80 percent in 1993, 82 percent in 1994 and 1995, 84 percent in 1996 and 1997, increasing to 88.7 percent in 1998 and thereafter at which time the 88.7 percent cap is applicable during all hours. For all economic energy deliveries above the caps to 915 MW, the option also allows Consumers to recover 1/2 cent per kWh capacity payment in addition to the corresponding energy charge.\nIn December 1992, Consumers recognized an after-tax loss of $343 million for the present value of estimated future underrecoveries of power costs under the PPA as a result of the Settlement Order. This loss included management's best estimates regarding the future availability of the MCV Facility, and the effect of the future wholesale power market on the amount, timing and price at which various increments of the capacity above the MPSC-authorized level could be resold. Except for adjustments to the above loss to reflect the after-tax time value of money through accretion expense, no additional losses are expected unless actual future experience materially differs from management's estimates. Because the calculation of the 1992 loss depended in part upon estimates of future unregulated sales of energy to third parties, a more conservative or risk-free investment rate of 7 percent was used to calculate $188 million of the total $343 million after-tax loss. The remaining portion of the loss was calculated using an 8.5 percent discount rate reflecting Consumers' incremental borrowing rate as required by SFAS 90, Regulated Enterprises- Accounting for Abandonments and Disallowances of Plant Costs. The after- tax expense for the time value of money for the loss is estimated to be approximately $24 million in 1994, and various lower levels thereafter, including $22 million in 1995 and $20 million in 1996. Although the settlement losses were recorded in 1992, the after-tax cash underrecoveries, including fixed energy charges, associated with the Settlement Order were $59 million in 1993. Consumers believes there is and will be a market for the resale of capacity purchases from the MCV Partnership above the MPSC-authorized level. However, if Consumers is unable to sell any capacity above the current MPSC-authorized level, future additional after-tax losses and after-tax cash underrecoveries could be incurred. Consumers' estimates of its future after-tax cash underrecoveries and possible additional losses for the next five years if none of the additional capacity is sold are as follows:\nAfter-tax, In Millions 1994 1995 1996 1997 1998 ---- ---- ---- ---- ----\nExpected cash underrecoveries $56 $65 $62 $61 $ 8\nPossible additional under- recoveries and losses (a) $14 $20 $20 $22 $72\n(a) If unable to sell any capacity above the MPSC's authorized level\nThe undiscounted, after-tax amount of the $343 million loss was $789 million. At December 31, 1993, the after-tax present value of the Settlement Order liability had been reduced to $307 million, which reflects after-tax cash underrecoveries related to capacity totaling $(54) million, after-tax accretion expense of $23 million and a $(5) million adjustment due to the 1993 corporate tax rate change (see Note 5).\nThe PPA, while requiring payment of a fixed energy charge, contains a \"regulatory out\" provision which permits Consumers to reduce the fixed energy charges payable to the MCV Partnership throughout the entire contract term if Consumers is not able to recover these amounts from its customers. In connection with the MPSC's approval of the Revised Settlement Proposal, Consumers and the MCV Partnership have commenced arbitration proceedings under the PPA to determine whether Consumers is entitled to exercise its regulatory out regarding fixed energy charges on the portion of available MCV capacity above the current MPSC-authorized levels. An arbitrator acceptable to both parties has been selected. If the arbitrator determines that Consumers cannot exercise its regulatory out, Consumers would be required to make these fixed energy payments to the MCV Partnership even though Consumers may not be recovering these costs. The arbitration proceedings will also determine who is entitled to the fixed energy amounts for which Consumers did not receive full cost recovery during the years prior to settlement. Although Consumers believes its position on arbitration is sound and intends to aggressively pursue its right to exercise the regulatory out, management cannot predict the outcome of the arbitration proceedings or any possible settlement of the matter. Accordingly, losses were recorded prior to 1993 for all fixed energy amounts at issue in the arbitration. As of December 31, 1993, approximately $20 million has been escrowed by Consumers and is included in Consumers' temporary cash investments. In December 1993, Consumers made an irrevocable offer to pay through September 15, 2007, fixed energy charges to the MCV Partnership on all kWh delivered by the MCV Partnership to Consumers from the contract capacity in excess of 915 MW, which represents a portion of the fixed energy charges in dispute. Consumers made the offer to facilitate the sale of the remaining MCV Bonds in 1993.\nThe lessors of the MCV Facility have filed a lawsuit in federal district court against CMS Energy, Consumers and CMS Holdings. It alleges breach of contract, breach of fiduciary duty and negligent or willful misrepresentation relating to the MCV Partnership's failure to object to the Settlement Order in light of Consumers' interpretation of the Settlement Order, which is the subject of an arbitration between the MCV Partnership and Consumers. The action alleges damages in excess of $1 billion and seeks injunctive relief relative to Consumers' payments of the fixed energy charge. CMS Energy and Consumers believe that at all times they and CMS Holdings have conducted themselves properly and that the action is without merit. They also believe that a significant portion of the alleged damages represent fixed energy charges in dispute in the arbitration. CMS Energy and Consumers are unable to predict the outcome of this action.\nPSCR Matters: Consistent with the terms of the Settlement Order, Consumers has withdrawn its appeals of various MPSC orders issued in connection with the 1992, 1991 and 1990 PSCR cases. Consumers also agreed not to appeal any MCV-related issues raised in future orders for these plan cases and related reconciliations to the extent those issues are resolved by the Settlement Order. Consumers made refunds, including interest, of $69 million in 1993 and $29 million in 1992 to customers for overrecoveries in connection with the 1991 and 1990 PSCR reconciliation cases, respectively. These amounts were included in losses recorded prior to 1993. In 1992, Consumers recovered MCV power purchase costs consistent with the MPSC's 1992 plan case order, and does not anticipate that any MCV-related refunds will be required.\n4: Rate Matters\nElectric Rate Case\nConsumers filed a request with the MPSC in May 1993 to increase its electric rates. Subsequently, as a result of changed estimates, Consumers revised its requested electric rate increase to $133 million annually based on a 1994 test year. Consumers also requested an additional annual electric rate increase of $38 million based on a 1995 test year. Consumers' request included increased future expenditures primarily related to capital additions, demand-side management programs, operation and maintenance, higher depreciation and postretirement benefits computed under SFAS 106, Employers' Accounting for Postretirement Benefits Other than Pensions. The filing also proposed experimental incentive provisions that would either reward or penalize Consumers, based on its operating performance. In addition, Consumers would share any returns above its MPSC-authorized level with customers in exchange for the ability to earn not lower than one percentage point below its authorized level.\nIn March 1994, an ALJ issued a proposal for decision that recommended Consumers' 1994 final annual rate increase total approximately $83 million, and that the incremental requested 1995 increase not be granted at this time. The ALJ's recommendation included a lower return on electric common equity, reflected reduced anticipated debt costs due to the projected availability of more favorable interest rates and proposed a lower equity ratio for Consumers' projected capitalization structure. The ALJ did, however, generally support Consumers' rate design proposal to significantly reduce the level of subsidization of residential customers by commercial and industrial customers and generally supported the performance incentive but not the shared return mechanism discussed above.\nAbandoned Midland Project: In July 1984, Consumers abandoned construction of its unfinished nuclear power plant located in Midland, Michigan, and subsequently took a series of write-downs. In May 1991, Consumers began collecting $35 million pretax annually for the next 10 years and is amortizing the assets against current income over the recovery period using an interest method. Amortization for 1993, 1992 and 1991 was $28 million, $28 million and $18 million, respectively.\nConsumers was not permitted to earn a return on the portion of the abandoned Midland investment for which the MPSC was allowing recovery. Therefore, under SFAS 90, the recorded losses described above included amounts that reduced the recoverable asset to the present value of future recoveries. During the remaining recovery period, part of the prior losses will be reversed to adjust the unrecovered asset to its present value. and is reflected as accretion income. An after-tax total of approximately $35 million of the prior losses remains to be included in accretion income through April 2001. Several parties, including the Attorney General, have filed claims of appeal with the Court of Appeals regarding MPSC orders issued in May and July 1991 that specified the recovery of abandoned investment.\nElectric Demand-side Management: As a result of settlement discussions regarding demand-side management and an MPSC order in July 1991, Consumers agreed to spend $65 million over two years on demand-side management programs. Based on the MPSC's determination of Consumers' effectiveness in implementing these programs, Consumers' future rate of return on common equity may be adjusted either upward by up to 1 percent or downward by up to 2 percent. This adjustment, if implemented, would be applied to Consumers' retail electric tariff rates and be in effect for one year following reconciliation hearings with the MPSC that are expected to be initiated in the first quarter of 1994. The estimated revenue effects of the potential adjustment range from an $11 million increase to a $22 million decrease. Consumers believes it will receive an increase on its return on common equity based on having achieved all of the agreed upon objectives.\nOn October 1, 1993, Consumers completed the customer participation portion of these programs and as part of its current electric rate case has requested MPSC authorization to continue certain programs in 1994. Consumers has also requested recovery of demand-side management expenditures which exceeded the $65 million level. Consumers is deferring program costs and amortizing the costs over the period these costs are being recovered from its customers in accordance with an accounting order issued by the MPSC in September 1992. The unamortized balance of deferred costs at December 31, 1993 and 1992 was $71 million and $25 million, respectively.\nPSCR Issues\nConsumers began a planned refueling and maintenance outage at Palisades in June 1993. Following several required, unanticipated repairs that extended the outage, the plant returned to service in early November. Recovery of replacement power costs incurred by Consumers during the outage will be reviewed by the MPSC during the 1993 PSCR reconciliation of actual costs and revenues to determine the prudency of actions taken during the outage. Any finding of delay due to imprudence could result in disallowances of a portion of replacement power costs. Net replacement power costs were approximately $180,000 per day above the cost of fuel incurred when the plant is operating.\nThe Energy Act imposes an obligation on the utility industry, including Consumers, to decommission DOE uranium enrichment facilities. Consumers currently estimates its payments for decommissioning those facilities to be $2.4 million per year for 15 years beginning in 1992, escalating based on an inflation factor. Consumers believes these costs are recoverable from its customers under traditional regulatory policies. As of December 31, 1993, Consumers' remaining estimated liability was approximately $34 million. Consumers has a regulatory asset of $34 million for the expected recovery of this amount in electric rates. GCR Issues\nIn connection with its 1991 GCR reconciliation case, Consumers refunded $36 million, including interest, to its firm sales and transportation rate customers in April 1992. Consumers accrued the full amount for this refund in 1991.\nThe MPSC issued an order during 1993 that approved an interim settlement agreement for the 12 months ended March 31, 1993. As a result of the settlement, Consumers refunded in August 1993, to its GCR and transportation customers, approximately $22 million, including interest. Consumers previously accrued amounts sufficient for this refund.\nThe MPSC, in a February 1993 order, provided that the price payable to certain intrastate gas producers by Consumers be reduced prospectively. As a result, Consumers was not allowed to recover approximately $13 million of costs incurred prior to February 8, 1993. In 1991, Consumers accrued a loss sufficient for this issue. Future disallowances are not anticipated, unless the remaining appeals filed by the intrastate producers are successful.\nIn 1992, the FERC approved a settlement involving Consumers, Trunkline and certain other parties, which resolved numerous claims and proceedings concerning Trunkline liquified natural gas costs. The settlement represents significant gas cost savings for Consumers and its customers in future years. As part of the settlement, Consumers will not incur any transition costs from Trunkline as a result of FERC Order 636. In November 1992, Consumers had recorded a liability and regulatory asset for the principal amount of payments to Trunkline over a five-year period and a regulatory asset. On May 11, 1993, the MPSC approved a separate settlement agreement that provides Consumers with full recovery of these costs over a five-year period. At December 31, 1993, Consumers' remaining liability and regulatory asset was $116 million.\nOther\nCertain of Consumers' direct gas suppliers have contract prices tied to the price Consumers pays Trunkline for its gas. On September 1, 1993, Consumers commenced gas purchases from Trunkline under a continuation of prior sales agreements. The current contract covers gas deliveries through October 1994 and is at a reduced price compared to prior gas sales. Some of Consumers' direct gas suppliers have claimed that the reduced Trunkline gas cost is not a proper reference price under their contracts with Consumers and that their contracts are terminable after a 12-month period. Consumers is disputing these claims. Additionally, three of these direct gas suppliers of Consumers have made filings with the FERC in Trunkline's Order 636 restructuring case seeking to preclude Trunkline's ability to make the sales to Consumers which commenced on September 1, 1993. Consumers and Trunkline vigorously opposed these filings and in December 1993, the FERC issued an order which, among other things, allowed Trunkline to continue sales of gas to Consumers under tariffs on file with the FERC.\nEstimated losses for certain contingencies discussed in this note have been accrued. Resolution of these contingencies is not expected to have a material impact on the financial statements.\n5: Income Taxes\nConsumers and its subsidiaries file a consolidated federal income tax return with CMS Energy. Income taxes are generally allocated to each company based on each company's separate taxable income. Consumers' accrued federal income tax benefits from CMS Energy were $49 million and $3 million as of December 31, 1993 and 1992, respectively. In 1992, Consumers implemented SFAS 109, Accounting for Income Taxes. Deferred tax assets and liabilities are classified as current or noncurrent based on the classification of the related asset or liability, for all temporary differences. Consumers began practicing full deferred tax accounting for temporary differences arising after January 1, 1993, as authorized by a generic MPSC order. The generic order reduces the amount of regulatory assets and liabilities that otherwise could have arisen in future periods by allowing Consumers to reflect the income statement effect in the period temporary differences arise.\nConsumers uses ITC to reduce current income taxes payable and defers and amortizes ITC over the life of the related property. The AMT requires taxpayers to perform a second separate federal tax calculation based on a flat rate applied to a broader tax base. AMT is the amount by which this \"broader-based\" tax exceeds regular tax. Any AMT paid generally becomes a tax credit that can be carried forward indefinitely to reduce regular tax liabilities in future periods when regular taxes paid exceed the tax calculated for AMT.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 increased the statutory federal tax rate from 34 percent to 35 percent effective January 1, 1993. The cumulative effect of this tax rate change has been reflected in Consumers' financial statements.\nThe significant components of income tax expense (benefit) consisted of:\nIn Millions Years Ended December 31 1993 1992 1991(a) - ----------------------- ------- ------ -------- Current federal income taxes $ 41 $ 52 $ 58 Deferred income taxes 61 (172) (166) Deferred income taxes - tax rate change (2) - - Deferred ITC, net (9) (7) 33 ------- ------ ------ $ 91 $(127) $(75) ======= ====== ======\nOperating $ 116 $ 51 $ 48 Other (25) (178) (123) ------- ------ ------ $ 91 $(127) $(75) ======= ====== ======\n(a) The 1991 provision for income taxes was before an extraordinary item that had related deferred income taxes of approximately $7 million.\nThe principal components of Consumers' deferred tax assets (liabilities) recognized in the balance sheet are as follows:\nIn Millions December 31 1993 1992 - ----------- ------- -------- Property $ (518) $ (458) Unconsolidated investments (184) (129) Postretirement benefits (Note 10) (178) (165) Abandoned Midland project (Note 4) (57) (60) Employee benefit obligations (includes postretirement benefits of $178 and $165) (Note 10) 200 186 MCV power purchases - settlement (Note 3) 165 177 AMT carryforward 64 51 ITC carryforward (expires 2005) 48 49 Other (8) (4) ------- -------- $ (468) $ (353) ======= ========\nGross deferred tax liabilities $(1,319) $(1,228) Gross deferred tax assets 851 875 -------- -------- $ (468) $ (353) ======== ========\nThe actual income tax expense (benefit) differs from the amount computed by applying the statutory federal tax rate to income before income taxes as follows:\nIn Millions Years Ended December 31 1993 1992 1991 ------- ------- ------- Net income (loss) before extraordinary item $ 198 $(244) $(235) Income tax expense (benefit) 91 (127) (75) ------- ------- ------- 289 (371) (310) Statutory federal income tax rate x 35% x 34% x 34% -------- ------- ------- Expected income tax expense (benefit) 101 (126) (105) Increase (decrease) in taxes from: Capitalized overheads previously flowed through 5 5 35 Differences in book and tax depreciation not previously deferred 6 9 8 ITC amortization and utilization (10) (10) (7) Affiliated companies' dividends (6) (5) (5) Other, net (5) - (1) ------- ------- ------- $ 91 $(127) $ (75) ======= ======= =======\n6: Short-Term Financings\nConsumers has authorization from the FERC to issue or guarantee up to $900 million of short-term debt through December 31, 1994. Consumers has a $470 million facility that is used to finance seasonal working capital requirements and unsecured, committed lines of credit aggregating $165 million. As of December 31, 1993, $235 million and $24 million were outstanding at weighted average interest rates of 4.0 percent and 3.9 percent, respectively. Further, Consumers has an established $500 million trade receivables purchase and sale program. As of December 31, 1993 and 1992, receivables sold under the agreement totaled $285 million and $225 million, respectively. On February 15, 1994, Consumers increased the level of receivables sold to $335 million.\n7: Capitalization\nCapital Stock\nAs of December 31, 1992, Consumers effected a quasi-reorganization, an elective accounting procedure in which Consumers' accumulated deficit of $574 million was eliminated against other paid-in capital. The fair values of Consumers' assets and liabilities at the date of the quasi- reorganization were determined by management to approximate their carrying values and no material adjustments to the historical bases were made. This action was approved by Consumers' Board of Directors and did not require shareholder approval. As a result of the quasi-reorganization and subsequent accumulated earnings, Consumers paid $133 million in common stock dividends in 1993 and also declared from 1993 earnings a $16 million common stock dividend in January 1994. Consumers has authorization from the MPSC and is proceeding to issue $200 million of preferred stock in 1994.\nFirst Mortgage Bonds\nConsumers secures its first mortgage bonds by a mortgage and lien on substantially all of its property. Consumers' ability to issue and sell securities is restricted by certain provisions in its First Mortgage Bond Indenture, Articles and the need for regulatory approvals in compliance with appropriate state and federal law. In September 1993, Consumers issued, with MPSC approval, $300 million of 6 3/8 percent first mortgage bonds, due 2003 and $300 million of 7 3/8 percent first mortgage bonds, due 2023. Consumers used the net proceeds from the bond issuance to refund approximately $515 million of higher interest first mortgage bonds and the balance to reduce short-term borrowings. Unamortized debt costs, premiums and discounts and call premiums on the refunded debt totaling approximately $18 million were deferred under SFAS 71, and are being amortized over the lives of the new debt.\nIn February 1994, Consumers issued a call for redemption totaling approximately $10 million. Consumers also fully redeemed two issues of first mortgage bonds totaling approximately $91 million. These redemptions completed Consumers' commitment to the MPSC, under the 1993 authorization to issue first mortgage bonds, to refinance certain long- term debt.\nLong-Term Bank Debt\nUnder its long-term credit agreement at December 31, 1993, Consumers was required to make 10 remaining quarterly principal payments of approximately $47 million. As of December 31, 1993, the outstanding balance under this credit agreement totaled $469 million with a weighted average interest rate of 4.0 percent. In January 1993, Consumers entered into an interest rate swap agreement, exchanging variable-rate interest for fixed-rate interest on the latest maturing $250 million of the then remaining $500 million obligation under its long-term credit agreement.\nOther\nConsumers has a total of $131 million of PCRBs outstanding with a weighted average interest rate of 4.2 percent as of December 31, 1993. Consumers classifies $101 million of PCRBs as long-term because it can refinance these amounts through irrevocable letters of credit expiring after one year.\nIn June 1993, Consumers entered into loan agreements in connection with the issuance of approximately $28 million of adjustable rate demand limited obligation refunding revenue bonds, due 2010, which are secured by an irrevocable letter of credit expiring in 1996. These bonds bear an initial interest rate of 2.65 percent. Consumers also entered into loan agreements in connection with the issuance of $30 million of 5.8 percent limited obligation refunding revenue bonds, due 2010, secured by a financial guaranty insurance policy and certain first mortgage bonds of Consumers. Proceeds of these issues were used to redeem on August 1, 1993 in advance of their maturities, approximately $58 million of outstanding PCRBs.\n8: Financial Instruments\nCash, short-term investments and current liabilities approximate their fair value due to the short-term nature of those instruments. The estimated fair value of long-term investments is based on quoted market prices where available. When specific market prices do not exist for an instrument, the fair value is based on quoted market prices of similar investments or other valuation techniques. All long-term investments in financial instruments, except as shown below, approximate fair value. Although the current fair value of the long-term debt, which is based on calculations made by debt pricing specialists, may be greater than the current carrying amount, settlement of the reported debt is generally not expected until maturity. The estimated fair values of Consumers' financial instruments are as follows:\nIn Millions Years Ended December 31 1993 1992 - ----------------------- ----------------- ----------------- Carrying Fair Carrying Fair Amount Value Amount Value\nInvestment in stock of affiliates $ 291 $ 323 $ 291 $ 303 Long-term debt 1,839 1,984 2,079 2,123\nThe fair value of Consumers' off-balance sheet financial instruments is based on the amount estimated to terminate or settle the obligation:\nIn Millions Years Ended December 31 1993 1992 ---------- ---------- Fair Value Fair Value\nInterest rate swaps (Note 7) $ 5 $ - Guarantees 7 7\nOn January 1, 1994, Consumers adopted SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, requiring accounting for investments in debt securities to be held to maturity at amortized cost; otherwise debt and marketable equity securities would be recorded at fair value, with any unrealized gains or losses included in earnings if the security is held for trading purposes or as a separate component of shareholders' equity if the security is available for sale. The implementation resulted in an increase in assets of $30 million in January 1994 with a corresponding increase in stockholders' equity of $20 million, net of tax.\nIn May 1993, the FASB issued SFAS 114, Accounting by Creditors for Impairment of a Loan, effective in 1995, requiring certain loans that are determined to be impaired be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of any collateral for a secured loan. Consumers does not believe this standard will have a material impact on its financial position or results of operations.\n9: Executive Incentive Compensation\nConsumers participates in CMS Energy's Performance Incentive Stock Plan. Under the plan, restricted shares of common stock of CMS Energy, stock options and stock appreciation rights may be granted to key employees based on their contributions to the successful management of CMS Energy and its subsidiaries. The plan reserves for award not more than 2 percent of CMS Energy's common stock outstanding on January 1 each year, less the number of shares of restricted common stock awarded and of common stock subject to options granted under the plan during the immediately preceding four calendar years. Any forfeitures are subject to award under the plan. As of December 31, 1993, awards of up to 447,686 shares of common stock may be issued.\nRestricted shares of common stock are outstanding shares with full voting and dividend rights. Performance criteria were added in 1990 based on CMS Energy's total return to shareholders. Shares of restricted common stock cannot be distributed until they are vested and the performance objectives are met. Further, the restricted stock is subject to forfeiture if employment terminates before vesting. If key employees exceed performance objectives, the plan will allow additional awards. Restricted shares vest fully if control of CMS Energy changes, as defined by the plan.\nConsumers' Executive Stock Option and Stock Appreciation Rights Plan, an earlier plan approved by shareholders, remains in effect until all authorized options are granted or September 25, 1995. As of December 31, 1993, options for 43,000 shares remained to be granted.\nUnder both plans, for stock options and stock appreciation rights, the exercise price on each grant date equaled the closing market price on the grant date. Options are exercisable upon grant and expire up to 10 years and one month from date of grant. The status of the restricted stock granted under the Performance Incentive Stock Plan and options granted under both plans follows. The number of shares presented also includes shares for employees of CMS Energy and non-utility affiliates.\nRestricted Stock Options ---------- ---------------------------- Number Number Price of Shares of Shares per Share ----------- --------- --------------- Outstanding at January 1, 1991 212,500 1,162,216 $ 7.13 - $34.25 Granted 97,000 194,000 $ 21.13 - $21.13 Exercised or Issued (34,437) (65,125) $ 7.13 - $16.00 --------- ---------- --------------- Outstanding at December 31, 1991 275,063 1,291,091 $ 7.13 - $34.25 Granted 101,000 215,000 $ 17.13 - $18.00 Exercised or Issued (37,422) (21,000) $ 13.00 - $16.00 Canceled (15,375) (50,000) $ 20.50 - $33.88 --------- ---------- --------------- Outstanding at December 31, 1992 323,266 1,435,091 $ 7.13 - $34.25 Granted 132,000 249,000 $ 25.13 - $26.25 Exercised or Issued (54,938) (152,125) $ 7.13 - $21.13 Canceled (84,141) (33,000) $ 20.50 - $33.88 --------- ---------- ---------------\nOutstanding at December 31, 1993 316,187 1,498,966 $ 7.13 - $34.25 ========= ========== ===============\n10: Retirement Benefits\nPostretirement Benefit Plans Other Than Pensions\nConsumers adopted SFAS 106 effective as of the beginning of 1992. The standard required Consumers to change its accounting for the cost of health care and life insurance benefits that are provided to retirees from a pay-as-you-go (cash) method to a full accrual method. Accordingly, Consumers recorded a liability of $466 million for the accumulated transition obligation and a corresponding regulatory asset for anticipated recovery in utility rates.\nBoth the MPSC and FERC have generally adopted SFAS 106 costs for ratemaking purposes provided costs recovered through rates are placed in external funds until they are needed to pay benefits. The MPSC's generic order allows utilities three years to seek recovery of costs and provides for recovery from customers of any deferred costs incurred prior to the beginning of rate recovery of such costs. Consumers anticipates recovering its regulatory asset within 20 years. As discussed in Note 4, Consumers has requested recovery of the portion of these costs allocated to the electric business. In late 1994, Consumers plans to request recovery of the gas utility portion of these costs. Consumers plans to fund the benefits using external Voluntary Employee Beneficiary Associations. Funding of the health care benefits would begin when Consumers' rate recovery based on SFAS 106 begins. A portion of the life insurance benefits have previously been funded.\nAs of December 31, 1993, the actuary assumed that retiree health care costs increased 10.5 percent in 1994 then decreased gradually to 5.5 percent in 2000 and thereafter. The health care cost trend rate assumption significantly affects the amounts reported. For example, a 1 percentage point increase in each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $75 million and the aggregate of the service and interest cost components of net periodic postretirement benefit costs for 1993 by $9 million.\nFor the years ended December 31, 1993 and 1992, the weighted average discount rate was 7.25 percent and 8 percent, respectively, and the expected long-term rate of return on plan assets was 8.5 percent. Net periodic postretirement benefit cost for health care benefits and life insurance benefits was $51 million in 1993 and $49 million in 1992. The 1993 and 1992 cost was comprised of $13 million and $10 million for service plus $38 million and $39 million for interest, respectively.\nThe funded status of the postretirement benefit plans is reconciled with the liability recorded at December 31 as follows:\nIn Millions 1993 1992 ------- ------- Actuarial present value of estimated benefits Retirees $ 281 $ 264 Eligible for retirement 54 50 Active (upon retirement) 187 175 ------- ------- Accumulated postretirement benefit obligation 522 489 Plan assets (premium deposit fund) at fair value 4 4 ------- ------- Projected postretirement benefit obligation in excess of plan assets (518) (485) Unrecognized net loss from experience different than assumed 8 - ------- ------- Recorded liability and regulatory asset $ (510) $ (485) ======= =======\nConsumers' postretirement health care plan is unfunded; the accumulated postretirement benefit obligation for that plan is $510 million and $478 million at December 31, 1993 and 1992, respectively.\nSupplemental Executive Retirement Plan\nCertain management employees qualify under the SERP. Benefits are based on the employee's service and earnings as defined in the SERP. In 1988, a trust from which SERP benefits are paid was established and funded. Because the SERP is not a qualified plan under the Internal Revenue Code, earnings of the trust are taxable and trust assets are included in Consumers' consolidated assets. As of December 31, 1993 and 1992, trust assets at cost (which approximates market) were $16 million and $14 million, respectively, and were classified as other non-current assets.\nDefined Benefit Pension Plan\nA trusteed, non-contributory, defined benefit Pension Plan covers substantially all employees. The benefits are based on an employee's years of accredited service and earnings, as defined in the plan, during an employee's five highest years of earnings. Because the plan is fully funded, no contributions were made for plan years 1991 through 1993. Amounts presented for the Pension Plan include amounts for CMS Energy and non-utility affiliates, which are not distinguishable from nor are they significant when compared with the plan's total amounts.\nYears Ended December 31 1993 1992 1991 - ----------------------- ----- ----- ----- Discount rate 7.25% 8.5% 8.5% Rate of compensation increase 4.5% 5.5% 5.5% Expected long-term rate of return on assets 8.75% 8.75% 8.75%\nNet Pension Plan and SERP costs consisted of:\nIn Millions Years Ended December 31 1993 1992 1991 ----- ----- ----- Service cost $ 19 $ 19 $ 18 Interest cost 49 47 48 Actual return on plan assets (92) (36) (88) Net amortization and deferral 34 (20) 28 ----- ----- ----- Net periodic pension cost $ 10 $ 10 $ 6 ===== ===== =====\nThe funded status of the Pension Plan and SERP reconciled to the pension liability recorded at December 31 was:\nIn Millions Pension Plan SERP ------------- ------------- 1993 1992 1993 1992 ----- ----- ----- ----- Actuarial present value of estimated benefits Vested $ 471 $ 349 $ 12 $ 10 Non-vested 56 49 - - ------ ------ ----- ----- Accumulated benefit obligation 527 398 12 10 Provision for future pay increases 138 177 5 5 ------ ------ ----- ----- Projected benefit obligation 665 575 17 15 Plan assets (primarily stocks and bonds,including $87 in 1993 and $64 in 1992 in common stock of CMS Energy) at fair value 692 631 - - ------ ------ ----- ----- Projected benefit obligation less than (in excess of) plan assets 27 56 (17) (15) Unrecognized net (gain) loss from experience different than assumed (56) (76) 5 2 Unrecognized prior service cost 45 49 - 1 Unrecognized net transition (asset) obligation (44) (49) 1 1 ------ ------ ------ ----- Recorded liability $ (28) $ (20) $ (11) $(11) ====== ====== ====== =====\nBeginning January 1, 1986, the amortization period for the Pension Plan's unrecognized net transition asset is 16 years and 11 years for the SERP's unrecognized net transition obligation. Prior service costs are amortized on a straight-line basis over the average remaining service period of active employees.\nIn 1991, certain eligible employees accepted early retirement incentives. The incentives consisted of lump-sum cash payments and increased pension payments. The pretax cost of the incentives was $25 million. Also in 1991, portions of the projected benefit obligation were settled which resulted in a pretax gain of $25 million that offset the early retirement costs.\n11: Leases\nConsumers leases various assets, including vehicles, aircraft, construction equipment, computer equipment, nuclear fuel and buildings. Consumers' nuclear fuel capital leasing arrangement was extended an additional year and is now scheduled to expire in November 1995. The maximum amount of nuclear fuel that can be leased increased from $55 million to $70 million. Consumers further increased this amount in early 1994 to $80 million. The lease provides for an additional one-year extension upon mutual agreement by the parties. Upon termination of the lease, the lessor would be entitled to a cash payment equal to its remaining investment, which was $57 million as of December 31, 1993. Consumers is responsible for payment of taxes, maintenance, operating costs, and insurance.\nMinimum rental commitments under Consumers' non-cancelable leases at December 31, 1993, were:\nIn Millions Capital Operating Leases Leases ------- --------- 1994 $ 40 $ 7 1995 57 6 1996 16 2 1997 15 2 1998 13 2 1999 and thereafter 26 21 ----- ----- Total minimum lease payments 167 $ 40 ===== Less imputed interest 27 -----\nPresent value of net minimum lease payments 140 Less current portion 34 -----\nNon-current portion (a) $106 =====\n(a) In January 1994, Consumers amended its nuclear fuel lease to include fuel previously owned at Big Rock Point. This is estimated to increase the non-current portion of capital leases by approximately $6 million.\nConsumers recovers these charges from customers and accordingly charges payments for its capital and operating leases to operating expense. Operating lease charges, including charges to clearing and other accounts as of December 31, 1993, 1992 and 1991, were $8 million, $12 million and $12 million, respectively.\nCapital lease expenses for the years ended December 31, 1993, 1992 and 1991 were $32 million, $44 million and $48 million, respectively. Included in these amounts for the years ended 1993, 1992 and 1991, are nuclear fuel lease expenses of $13 million, $17 million and $24 million, respectively.\n12: Commitments and Contingencies\nLudington Pumped Storage Plant Litigation\nIn 1986, the Attorney General filed a lawsuit on behalf of the State of Michigan in the Circuit Court of Ingham County, seeking damages from Consumers and Detroit Edison for alleged injuries to fishery resources because of the operation of the Ludington Pumped Storage Plant. The state sought $148 million (including $16 million of interest) for past injuries and $89,000 per day for future injuries, with the latter amount to be adjusted upon installation of \"adequate\" fish barriers and other changed conditions.\nIn 1987, the Attorney General filed a second lawsuit alleging that Consumers and Detroit Edison have breached a bottomlands lease agreement with the state and asked that the lease be declared void. This complaint was consolidated with the suit described in the preceding paragraph. In 1990, both of the lawsuits were dismissed on the basis of federal preemption. In 1993, the Court of Appeals overturned the dismissal, as to damages, effectively allowing the state to continue its damages lawsuit against Consumers and Detroit Edison, but generally affirmed the lower court's ruling as to the breach of lease claim. The Court of Appeals' ruling also limited any potential damages to those occurring no earlier than 1983. Consumers, Detroit Edison and the Attorney General have filed an application for leave to appeal with the Michigan Supreme Court. Consumers and Detroit Edison are seeking to have the trial court's dismissal of the damages claim affirmed.\nEach year since 1989, Consumers and Detroit Edison have complied with FERC orders by installing a seasonal barrier net from April to October at the Ludington plant site. The FERC is now considering whether the barrier net (along with other actions by Consumers, including contributions to state fish-stocking programs) would be a satisfactory permanent solution.\nEnvironmental Matters\nConsumers is a so-called \"Potentially Responsible Party\" at several sites being administered under Superfund. Along with Consumers, there are numerous credit-worthy, potentially responsible parties with substantial assets cooperating with respect to the individual sites. Based on information currently known by management, Consumers believes that it is unlikely that its liability at any of the known Superfund sites, individually or in total, will have a material adverse effect on its financial position or results of operations.\nThe State of Michigan in 1990 passed amendments to the Environmental Response Act that established a state program similar to the federal Superfund law, though broader in scope. Under this law, Consumers expects that it will ultimately incur costs at a number of sites, including some of the 23 sites that formerly housed manufactured gas plant facilities, even those in which it has a partial or no current ownership interest. It is expected that in most cases, parties other than Consumers with current or former ownership interests may also be considered liable under the law and may be required to share in the costs of any site investigations and remedial actions. There is limited knowledge of manufactured gas plant contamination at these sites at this time. However, Consumers is continuing to monitor this issue.\nIn addition, at the request of the DNR, Consumers prepared plans for remedial investigation/feasibility studies for three of these sites. Work plans for remedial investigation/feasibility studies for four other sites have also been prepared. The purpose of a remedial investigation/feasibility study is to define the nature and extent of contamination at a site and to determine which of several possible remedial action alternatives, including no action, may be required under the Environmental Response Act. The DNR has approved two of the three plans for remedial investigation/feasibility studies submitted and is currently reviewing the one remaining. The cost to conduct one of the approved studies will be approximately $250,000 based on bids received. Although the actual cost of conducting the remaining two remedial investigation/feasibility studies will not be known until bids are received from contractors, Consumers currently estimates the total cost of conducting the three studies submitted to the DNR to be less than $1 million.\nThe timing and extent of any further site investigation and remedial actions will depend, among other things, on requests received from the DNR and on future site usage by Consumers or other owners. Under the current schedule, Consumers anticipates the first remedial investigation/feasibility study would be completed in mid-1994. Consumers believes the results of the remedial investigation/feasibility studies will allow management to estimate a range of remedial cost estimates for the sites under study. Based on Consumers' knowledge of other utility remedial actions, remediation costs for Consumers for these sites may be substantial. In 1993, the MPSC addressed the question of recovery of investigation and remedial costs for another Michigan gas utility as part of that utility's gas rate case. In that proceeding, the MPSC determined that prudent investigation and remedial costs could be deferred and amortized over 10-year periods and prudent unamortized costs can be included for recovery in the utility's rate cases. The MPSC stated the length of the period may be reviewed from time to time, but any revisions would be prospective. Consumers believes costs incurred for both investigation and any required remedial actions would be recoverable from its customers under established regulatory policies and accordingly are not likely to materially affect its financial position or results of operations.\nIncluded in the 1990 amendments to the federal Clean Air Act are provisions that limit emissions of sulfur dioxide and nitrogen oxides and require enhanced emissions monitoring. All of Consumers' coal-fueled electric generating units burn low-sulfur coal and are presently operating at or near the sulfur dioxide emission limits which will be effective in 2000. Beginning in 1995, certain coal-fueled generating units will receive emissions allowances (all of Consumers' coal units will receive allowances beginning in 2000). Based on projected emissions from these units, Consumers expects to have excess allowances which may be sold or saved for future use.\nThe Clean Air Act's provisions require Consumers to make capital expenditures estimated to total $74 million through 1999 for completed, in-process and possible modifications at coal-fired units based on existing and proposed regulations. Management believes that Consumers' annual operating costs will not be materially affected.\nThe EPA has asked a number of utilities in the Great Lakes area to voluntarily retire certain equipment containing specific levels of polychlorinated biphenyls. Consumers believes that it is largely in compliance with the EPA's petition. Consumers is continuing to study the request and has been granted an extension for responding until March 30, 1994.\nCapital Expenditures\nConsumers estimates capital expenditures, including demand-side management and new lease commitments, of $553 million for 1994, $461 million for 1995 and $471 million for 1996.\nPublic Utility Holding Company Act Exemption\nCMS Energy is exempt from registration under PUHCA. However, the Attorney General and the MMCG have asked the SEC to revoke CMS Energy's exemption from registration under PUHCA. In 1992, the MPSC filed a statement with the SEC recommending that CMS Energy's current exemption be revoked and a new exemption be issued conditioned upon certain reporting and operating requirements. If CMS Energy were to lose its current exemption, it would become more heavily regulated by the SEC; Consumers could ultimately be forced to divest either its electric or gas utility business; and CMS Energy would be restricted from conducting businesses that are not functionally related to the conduct of its utility business as determined by the SEC. CMS Energy is opposing this request and believes it will maintain its current exemption from registration under PUHCA.\nOther\nConsumers experienced an increase in complaints during 1993 relating to so-called stray voltage. Claimants contend that stray voltage results when small electrical currents present in grounded electric systems are diverted from their intended path. Investigation by Consumers of prior stray voltage complaints disclosed that many factors, including improper wiring and malfunctioning of on-farm equipment, can lead to the stray voltage phenomenon. Consumers maintains a policy of investigating all customer calls regarding stray voltage and working with customers to address their concerns including, when necessary, modifying the configuration of the customer's hook-up to Consumers. A complaint seeking certification as a class action suit was filed against Consumers in a local county circuit court in 1993. The complaint alleges the existence of a purported class that has incurred damages of up to $1 billion, primarily to certain livestock owned by the purported class, as a result of stray voltage from electricity being supplied by Consumers. Consumers believes the allegations to be without merit and intends to vigorously oppose the certification of the class and this suit.\nIn addition to the matters disclosed in these notes, Consumers and certain of its subsidiaries are parties to certain lawsuits and administrative proceedings before various courts and governmental agencies, arising from the ordinary course of business involving personal injury and property damage, contractual matters, environmental issues, federal and state taxes, rates, licensing and other matters.\nThe ultimate effect of the proceedings discussed in this note is not expected to have a material impact on Consumers' financial position or results of operations.\n13: Jointly Owned Utility Facilities\nConsumers is responsible for providing its share of financing for the jointly owned facilities. The following table indicates the extent of Consumers' investment in jointly owned utility facilities:\nIn Millions December 31 1993 1992 - ----------- ---- ---- Net investment Ludington - 51% $114 $112 Campbell Unit 3 - 93.3% 349 360 Transmission lines - various 32 33\nAccumulated depreciation Ludington $ 74 $ 71 Campbell Unit 3 210 199 Transmission lines 11 10\n14: Supplemental Cash Flow Information\nFor purposes of the Statement of Cash Flows, all highly liquid investments with an original maturity of three months or less are considered cash equivalents. Other cash flow activities and non-cash investing and financing activities for the years ended December 31 were:\nIn Millions 1993 1992 1991 ------ ------ ------ Cash transactions Interest paid (net of amounts capitalized) $177 $176 $308 Income taxes paid (net of refunds) 90 6 30\nNon-cash transactions Nuclear fuel placed under capital lease $ 28 $ 30 $ 6 Other assets placed under capital leases 30 39 21 Capital leases refinanced 42 - - Assumption of debt - 15 - Return of Midland related assets (Note 16) - - (92) Increased value of investment in Enterprises' preferred stock (Note 16) - - 100\nChanges in other assets and liabilities as shown on the Consolidated Statements of Cash Flows at December 31 are described below:\nIn Millions 1993 1992 1991 ------ ------ ------ Sale of receivables, net $ 60 $ 25 $ - Accounts receivable 19 30 66 Accrued revenue (48) 91 7 Inventories (32) 24 (8) Accounts payable (25) 21 (83) Accrued refunds (48) (143) 102 Tax Reform Act refund reserve - - (77) Other current assets and liabilities, net (59) 38 (56) Non-current deferred amounts, net 8 (36) 170 ------ ------ ----- $(125) $ 50 $ 121 ======= ====== ======\n15: Reportable Segments\nThe Consolidated Statements of Income show operating revenue and pretax operating income by segments. These amounts include earnings (losses) from investments accounted for by the equity method of $6 million, $(10) million and $(2) million for 1993, 1992 and 1991, respectively. Other segment information follows:\nIn Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Depreciation, depletion and amortization Electric $ 241 $ 230 $ 172 Gas 73 76 70 Other 2 1 - ------ ------ ------ $ 316 $ 307 $ 242 ====== ====== ======\nIdentifiable assets Electric (a) $4,027 $3,812 $3,399 Gas 1,443 1,387 1,186 Other (b) 1,081 1,397 1,401 ------ ------ ------ $6,551 $6,596 $5,986 ====== ====== ======\nCapital expenditures (c) Electric (d) $ 365 $ 353 $ 213 Gas 127 86 61 Other 69 67 32 ------ ------ ------ $ 561 $ 506 $ 306 ====== ====== ======\n(a) Includes abandoned Midland investment of $162 million, $175 million and $287 million for 1993, 1992 and 1991, respectively.\n(b) Reclassified 1992 and 1991 to include independent power production, which is no longer significant enough for Consumers to report separately. Also, other was reduced by the sale of $309 million of MCV Bonds (see Note 3).\n(c) Includes capital leases for nuclear fuel and other assets (see Note 14).\n(d) Includes DSM costs of $52 million for 1993 and $26 million for 1992.\n16: Related-Party Transactions\nConsumers has an investment of $250 million in 10 shares of the preferred stock of Enterprises, an affiliate company of Consumers. Prior to a 1991 amendment to Enterprises' Articles, it was to have redeemed on July 1, 1991 and in each of the next four years, two shares of its preferred stock held by Consumers at a redemption price equal to $25 million per share. Because of the amendment, the dividend rate increased and the first mandatory redemption date became August 1, 1997. The asset value and other paid-in capital of Consumers were increased $100 million as a result of the amendment. In addition, Consumers has an investment in approximately 3 million shares of CMS Energy common stock totaling $42 million at December 31, 1993. As a result of these two investments, Consumers received dividends on affiliates' common and preferred stock totaling $16 million in 1993 and 1992 and $13 million in 1991.\nIn March 1990, Consumers' subsidiary, MGL and Consumers' parent, CMS Energy, entered into an agreement where MGL exchanged its investment in several subsidiaries that held Midland-related assets for CMS Debentures issued by CMS Energy. Consumers recorded the earnings on the CMS Debentures as income from contractual arrangements. In December 1991, the subsidiaries were returned to Consumers and the CMS Debentures were cancelled to comply with various regulatory and court orders. On July 27, 1991, Consumers stopped recording income on the CMS Debentures when it became probable the return would be required. The return resulted in a net after-tax loss of approximately $92 million because the book value of the subsidiaries was less than the CMS Debentures' book value.\nConsumers purchases a portion of its gas from an affiliate, NOMECO. The amounts of purchases for the years ended 1993, 1992 and 1991 were $3 million, $3 million and $20 million, respectively. In 1993, 1992 and 1991, Consumers purchased $52 million, $36 million and $26 million, respectively, of electric generating capacity and energy from affiliates of Enterprises. Consumers and its subsidiaries sold, stored and transported natural gas and provided other services to the MCV Partnership totaling approximately $14 million for 1993, 1992 and 1991, respectively. For additional discussion of related-party transactions with the MCV Partnership and the FMLP, see Notes 3 and 17. Other related-party transactions are immaterial.\n17: Summarized Financial Information of Significant Related Energy Supplier\nUnder the PPA with the MCV Partnership discussed in Note 3, Consumers' 1993 obligation to purchase electricity from the MCV Partnership was approximately 14 percent of Consumers' owned and contracted capacity. Summarized financial information of the MCV Partnership is shown below:\nStatements of Income In Millions Years Ended December 31 1993 1992 1991 - ----------------------- ------ ------ ------ Operating revenue (a) $ 548 $ 488 $ 425 Operating expenses 362 315 278 ------ ------ ------ Operating income 186 173 147 Other expense, net (189) (190) (186) ------ ------ ------ Net loss $ (3) $ (17) $ (39) ====== ====== ======\nBalance Sheets In Millions December 31 1993 1992 - ----------- ------ ------ Assets Current assets (a) $ 181 $ 165 Property, plant and equipment, net 2,073 2,124 Other assets 146 147 ------ ------ $2,400 $2,436 ====== ======\nLiabilities and Partners' Equity Current liabilities $ 198 $ 189 Long-term debt and other non-current liabilities (b) 2,147 2,189 Partners' equity (c) 55 58 ------ ------ $2,400 $2,436 ====== ======\n(a) Revenue from Consumers totaled $505 million, $444 million and $384 million for 1993, 1992 and 1991, respectively. As of December 31, 1993, 1992 and 1991, $44 million, $38 million and $33 million, respectively, were receivable from Consumers.\n(b) FMLP is a beneficiary of an owner trust that is the lessor in a long-term direct finance lease with the lessee, MCV Partnership. CMS Holdings holds a 46.4 percent ownership interest in FMLP (see Note 3). At December 31, 1993 and 1992, lease obligations of $1.7 billion were owed to the owner trust of which FMLP is the sole beneficiary. CMS Holdings' share of the interest and principal portion for the 1993 lease payments was $63 million and $16 million, respectively, and for the 1992 lease payments was $65 million and $12 million, respectively. The lease payments service $1.2 billion and $1.3 billion in non-recourse debt outstanding as of December 31, 1993 and 1992, respectively, of the owner-trust whose beneficiary is FMLP. FMLP's debt is secured by the MCV Partnership's lease obligations, assets, and operating revenues. For 1993 and 1992, the owner-trust whose beneficiary is FMLP made debt payments of $172 million and $166 million, respectively, which included $10 million and $8 million principal and $25 million and $26 million interest, respectively, on the MCV Bonds held by MEC Development Corporation during part of 1991 and by Consumers through December 1993.\n(c) CMS Midland's recorded investment in the MCV Partnership includes capitalized interest, which is being amortized to expense over the life of its investment in the MCV Partnership.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of long-term debt and preferred stock of CONSUMERS POWER COMPANY (a Michigan corporation and wholly owned subsidiary of CMS Energy Corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1993. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Consumers Power Company and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes. As discussed in Note 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for postretirement benefits other than pensions. Additionally, as discussed in Note 7 to the consolidated financial statements, the Company effected a quasi-reorganization on December 31, 1992.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nCMS Energy\nNone for CMS Energy.\nConsumers\nNone for Consumers. PART III (ITEMS 10., 11., 12. and 13.) CMS Energy\nCMS Energy's definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.\n\n\nItem 10.\nConsumers\nConsumers' definitive Proxy Statement, except for the organization and compensation committee report contained therein, is incorporated by reference herein. See also Item 1. BUSINESS for information pursuant to Item 10.\nPART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent reports dated September 29, 1993, as amended by Form 8-K/A, Amendment No. 1, dated October 22, 1993, and dated December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and current reports dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent reports dated September 21, 1993 and December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Articles of Incorporation of CMS Energy Corporation, as Amended. (Designated in CMS Energy Corporation's Form S-8 dated June 30, 1989, File No 1-9513, as Exhibit (4).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation.\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company.\n(3)(d) - Copy of By-Laws of Consumers Power Company.\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind/Dated as of File Reference Exhibit ------------------- ---------------- -------\n44th 11/15/79 Reg No 2-65973 (b)(1)-7 45th 01/15/80 Reg No 2-68900 (b)(1)-5 46th 01/15/80 Reg No 2-69704 (4)(b) 47th 06/15/80 Form 10-K for year end Dec 31, 1980, File No 1-5611 (4)(b) 48th 03/15/81 Reg No 2-73741 (4)(b) 49th 11/01/81 Reg No 2-75542 (4)(b) 50th 03/01/82 Form 10-K for year end Dec 31, 1981, File No 1-5611 (4)(b) 51st 08/10/82 Reg No 2-78842 (4)(f) 52nd 08/31/82 Reg No 2-79390 (4)(f) 53rd 12/01/82 Reg No 2-81077 (4)(f) 54th 05/01/83 Reg No 2-84172 (4)(e) 55th 09/15/83 Reg No 2-86751 (4)(e) 56th 10/15/83 Reg No 2-87735 (4)(e) 57th 03/01/84 Reg No 2-89215 (4)(e) 58th 07/16/84 Form 10-Q for quarter ended June 30, 1984, File No 1-5611 (4)(f) 59th 10/01/84 Reg No 2-93438 (4)(c) 60th 06/01/85 Form 10-Q for quarter ended June 30, 1985, File No 1-5611 (4)(f) 61st 10/15/86 Reg No 33-9732 (4)(e) 63rd 04/15/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(f) 64th 06/15/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(g) 65th 02/15/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 66th 04/15/88 Form 10-Q for quarter ended March 31, 1988 File No 1-5611 (4)(d) 67th 11/15/89 Reg No 33-31866 (4)(d) 68th 06/15/93 Reg No 33-41126 (4)(c) 69th 09/15/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(5)-(9) - Not applicable.\n(10)(a) - Credit Agreement dated as of May 1, 1989 among Consumers Power Company, the Co-Managers, as defined therein, the Banks, as defined therein, the Lenders, as defined therein, and Citibank, NA, as Agent, and the Exhibits thereto. (Designated in Consumers Power Company's Form 10-Q for the quarter ended March 31, 1989, File No 1-5611, as Exhibit (19).)\nLetter amendment dated as of December 11, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 30, 1991, File No. 1-5611, as Exhibit (3)(d).)\n(10)(b) (CMS ONLY) - Amended and Restated Credit Agreement dated as of November 30, 1992 as Amended and Restated as of October 15, 1993, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent and the Operational Agent, all as defined therein, and the Exhibits thereto.\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment contract effective as of March 1, 1987 among CMS Energy Corporation, Consumers Power Company and S. Kinnie Smith, Jr. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1987, File No 1-5611, as Exhibit (10)(g).)\n(10)(e) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No 1-5611, as Exhibit (10)(i).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(f).)\n(10)(g) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(h) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(f).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(j) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(h).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994.\n(10)(n) - Consumers Power Company's Annual Executive Incentive Compensation Plan effective February 1993, as amended March 1994.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990.\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.13.)\nAmendment No 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.5.)\nAmendment No 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.6.)\nAmendment No 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.7.)\nAmendment No 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U- 10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24) - Powers of Attorney.\n(25)-(28) - Not applicable.\n*Five copies of this exhibit have been signed by, or on behalf of, each of five Owner Participants. With regard to each of the agreements, each copy is substantially identical in all material respects except as to the parties thereto. Therefore, pursuant to Instruction 2, Item 601(a) of Regulation S-K, CMS Energy Corporation and Consumers Power Company are filing a copy of only one such document.\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nSchedule Page\nV Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 154 Consumers Power Company 157\nVI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 160 Consumers Power Company 163\nVIII Valuation and Qualifying Accounts and Reserves 1993, 1992 and 1991: CMS Energy Corporation 166 Consumers Power Company 167\nIX Short-Term Borrowings 1993, 1992 and 1991: CMS Energy Corporation 168 Consumers Power Company 169\nX Supplementary Income Statement Information 1993, 1992 and 1991: CMS Energy Corporation 170 Consumers Power Company 171\nReport of Independent Public Accountants CMS Energy Corporation 172 Consumers Power Company 173\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. ---------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 18th day of March 1994.\nSignature Title - -------------------------------------- -----------------------------------\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director - ------------------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President, Controller P. D. Hopper and Chief Accounting Officer - ------------------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n* By Thomas A. McNish ------------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 18th day of March 1994.\nSignature Title - ------------------------------------- -----------------------------------\n(i) Principal executive officer:\nPresident and Michael G. Morris Chief Executive Officer - ------------------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller - ------------------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nWilliam T. McCormick, Jr. Director - ------------------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n*By Thomas A. McNish -------------------------------- Thomas A. McNish, Attorney-in-Fact\n\n\n\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) Financial Statements and Reports of Independent Public Accountants for CMS Energy and Consumers are listed in Item 8 in the Index to Financial Statements, and are incorporated by reference herein.\n(a)(2) Financial Statement Schedules and Reports of Independent Public Accountants for CMS Energy and Consumers are listed after the Exhibits in the Index to Financial Statement Schedules, and are incorporated by reference herein.\n(a)(3) Exhibits for CMS Energy and Consumers are listed after Item (c) below and are incorporated by reference herein.\n(b) Reports on Form 8-K for CMS Energy and Consumers.\nCMS Energy\nCurrent reports dated September 29, 1993, as amended by Form 8-K/A, Amendment No. 1, dated October 22, 1993, and dated December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and current reports dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\nConsumers\nCurrent reports dated September 21, 1993 and December 10, 1993 covering matters reported pursuant to Item 5. Other Events. and Item 7. Financial Statements and Exhibits., and dated December 28, 1993 and March 4, 1994 covering matters reported pursuant to Item 5. Other Events.\n(c) Exhibits, including those incorporated by reference (see also Exhibit volume).\nThe following exhibits are applicable to CMS Energy and Consumers except where otherwise indicated \"CMS ONLY\":\nCMS Energy and Consumers Exhibit Numbers - ---------------\n(1)-(2) - Not applicable.\n(3)(a) (CMS ONLY) - Articles of Incorporation of CMS Energy Corporation, as Amended. (Designated in CMS Energy Corporation's Form S-8 dated June 30, 1989, File No 1-9513, as Exhibit (4).)\n(3)(b) (CMS ONLY) - Copy of the By-Laws of CMS Energy Corporation.\n(3)(c) - Restated Articles of Incorporation of Consumers Power Company.\n(3)(d) - Copy of By-Laws of Consumers Power Company.\n(4)(a) - Composite Working Copy of Indenture dated as of September 1, 1945, between Consumers Power Company and Chemical Bank (successor to Manufacturers Hanover Trust Company), as Trustee, including therein indentures supplemental thereto through the Forty-third Supplemental Indenture dated as of May 1, 1979. (Designated in Consumers Power Company's Registration No 2-65973 as Exhibit (b)(1)-4.)\nIndentures Supplemental thereto:\nConsumers Power Company Sup Ind/Dated as of File Reference Exhibit ------------------- ---------------- -------\n44th 11/15/79 Reg No 2-65973 (b)(1)-7 45th 01/15/80 Reg No 2-68900 (b)(1)-5 46th 01/15/80 Reg No 2-69704 (4)(b) 47th 06/15/80 Form 10-K for year end Dec 31, 1980, File No 1-5611 (4)(b) 48th 03/15/81 Reg No 2-73741 (4)(b) 49th 11/01/81 Reg No 2-75542 (4)(b) 50th 03/01/82 Form 10-K for year end Dec 31, 1981, File No 1-5611 (4)(b) 51st 08/10/82 Reg No 2-78842 (4)(f) 52nd 08/31/82 Reg No 2-79390 (4)(f) 53rd 12/01/82 Reg No 2-81077 (4)(f) 54th 05/01/83 Reg No 2-84172 (4)(e) 55th 09/15/83 Reg No 2-86751 (4)(e) 56th 10/15/83 Reg No 2-87735 (4)(e) 57th 03/01/84 Reg No 2-89215 (4)(e) 58th 07/16/84 Form 10-Q for quarter ended June 30, 1984, File No 1-5611 (4)(f) 59th 10/01/84 Reg No 2-93438 (4)(c) 60th 06/01/85 Form 10-Q for quarter ended June 30, 1985, File No 1-5611 (4)(f) 61st 10/15/86 Reg No 33-9732 (4)(e) 63rd 04/15/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(f) 64th 06/15/87 Form 10-Q for quarter ended June 30, 1987 File No 1-5611 (4)(g) 65th 02/15/88 Form 8-K dated Feb 18, 1988 File No 1-5611 (4) 66th 04/15/88 Form 10-Q for quarter ended March 31, 1988 File No 1-5611 (4)(d) 67th 11/15/89 Reg No 33-31866 (4)(d) 68th 06/15/93 Reg No 33-41126 (4)(c) 69th 09/15/93 Form 8-K dated September 21, 1993 File No 1-5611 (4)\n(4)(b) (CMS ONLY) - Indenture between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form S-3 Registration Statement filed May 1, 1992, File No. 33-47629, as Exhibit (4)(a).)\nFirst Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\nSecond Supplemental Indenture dated as of October 1, 1992 between CMS Energy Corporation and NBD Bank, National Association, as Trustee. (Designated in CMS Energy's Form 8-K dated October 1, 1992, File No. 1-9513, as Exhibit (4).)\n(5)-(9) - Not applicable.\n(10)(a) - Credit Agreement dated as of May 1, 1989 among Consumers Power Company, the Co-Managers, as defined therein, the Banks, as defined therein, the Lenders, as defined therein, and Citibank, NA, as Agent, and the Exhibits thereto. (Designated in Consumers Power Company's Form 10-Q for the quarter ended March 31, 1989, File No 1-5611, as Exhibit (19).)\nLetter amendment dated as of December 11, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 30, 1991, File No. 1-5611, as Exhibit (3)(d).)\n(10)(b) (CMS ONLY) - Amended and Restated Credit Agreement dated as of November 30, 1992 as Amended and Restated as of October 15, 1993, among CMS Energy Corporation, the Banks, the Co-Agents, the Documentation Agent and the Operational Agent, all as defined therein, and the Exhibits thereto.\n(10)(c) - Employment Agreement dated as of August 1, 1990 among Consumers Power Company, CMS Energy Corporation and William T. McCormick, Jr. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(c).)\n(10)(d) - Employment contract effective as of March 1, 1987 among CMS Energy Corporation, Consumers Power Company and S. Kinnie Smith, Jr. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1987, File No 1-5611, as Exhibit (10)(g).)\n(10)(e) - Employment Agreement effective as of June 15, 1988 among Consumers Power Company, CMS Energy Corporation and Victor J. Fryling. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1988, File No 1-5611, as Exhibit (10)(i).)\n(10)(f) - Employment Agreement dated May 26, 1989 between Consumers Power Company and Michael G. Morris. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(f).)\n(10)(g) - Employment Agreement dated May 26, 1989 between Consumers Power Company and David A. Mikelonis. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit 10(h).)\n(10)(h) - Employment Agreement dated May 26, 1989 among Consumers Power Company, CMS Energy Corporation and John W. Clark. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(f).)\n(10)(i) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Alan M. Wright. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(j).)\n(10)(j) - Employment Agreement dated March 25, 1992 between Consumers Power Company and Paul A. Elbert. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1992, File No. 1-5611, as Exhibit 10(k).)\n(10)(k) - Consumers Power Company's Executive Stock Option and Stock Appreciation Rights Plan effective December 1, 1989. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1990, File No 1-5611, as Exhibit (10)(g).)\n(10)(l) - CMS Energy Corporation's Performance Incentive Stock Plan effective as of December 1, 1989. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(h).)\n(10)(m) - CMS Deferred Salary Savings Plan effective January 1, 1994.\n(10)(n) - Consumers Power Company's Annual Executive Incentive Compensation Plan effective February 1993, as amended March 1994.\n(10)(o) - Consumers Power Company's Supplemental Executive Retirement Plan effective November 1, 1990.\n(10)(p) - Senior Trust Indenture, Leasehold Mortgage and Security Agreement dated as of June 1, 1990 between The Connecticut National Bank and United States Trust Company of New York. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.1.)\nIndenture Supplemental thereto:\nSupplement No. 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.2.)\n(10)(q) - Collateral Trust Indenture dated as of June 1, 1990 among Midland Funding Corporation I, Midland Cogeneration Venture Limited Partnership and United States Trust Company of New York, Trustee. (Designated in CMS Energy Corporation's Form 10-Q for the quarter ended June 30, 1990, File No 1-9513, as Exhibit (28)(b).)\nIndenture Supplemental thereto:\nSupplement No 1 dated as of June 1, 1990. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.4.)\n(10)(r) - Amended and Restated Investor Partner Tax Indemnification Agreement dated as of June 1, 1990 among Investor Partners, CMS Midland Holdings Corporation as Indemnitor and CMS Energy Corporation as Guarantor. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(v).)\n(10)(s) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to The Connecticut National Bank and Others. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(y) and Form 10-Q for the quarter ended September 30, 1991, File No 1-9513, as Exhibit (19)(d).)**\n(10)(t) - Indemnity Agreement dated as of June 1, 1990 made by CMS Energy Corporation to Midland Cogeneration Venture Limited Partnership. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(z).)**\n(10)(u) - Environmental Agreement dated as of June 1, 1990 made by CMS Energy Corporation to United States Trust Company of New York, Meridian Trust Company, each Subordinated Collateral Trust Trustee and Holders from time to time of Senior Bonds and Subordinated Bonds and Participants from time to time in Senior Bonds and Subordinated Bonds. (Designated in CMS Energy Corporation's Form 10-K for the year ended December 31, 1990, File No 1-9513, as Exhibit (10)(aa).)**\n(10)(v) - Amended and Restated Participation Agreement dated as of June 1, 1990 among Midland Cogeneration Venture Limited Partnership, Owner Participant, The Connecticut National Bank, United States Trust Company, Meridian Trust Company, Midland Funding Corporation I, Midland Funding Corporation II, MEC Development Corporation and Institutional Senior Bond Purchasers. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 4.13.)\nAmendment No 1 dated as of July 1, 1991. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(w).)\n(10)(w) - Power Purchase Agreement dated as of July 17, 1986 between Midland Cogeneration Venture Limited Partnership and Consumers Power Company. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.4.)\nAmendments thereto:\nAmendment No 1 dated September 10, 1987. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.5.)\nAmendment No 2 dated March 18, 1988. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.6.)\nAmendment No 3 dated August 28, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.7.)\nAmendment No 4A dated May 25, 1989. (Designated in Midland Cogeneration Venture Limited Partnership's Form S-1 filed November 23, 1990, File No 33-37977, as Exhibit 10.8.)\n(10)(x) - Request for Approval of Settlement Proposal to Resolve MCV Cost Recovery Issues and Court Remand, filed with the Michigan Public Service Commission on July 7, 1992, MPSC Case No. U- 10127. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1991 as amended by Form 8 dated July 15, 1992 as Exhibit (28).)\n(10)(y) - Settlement Proposal Filed on July 7, 1992 as Revised on September 8, 1992 by Filing with the Michigan Public Service Commission. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 8-K dated September 8, 1992 as Exhibit (28).)\n(10)(z) - Michigan Public Service Commission Order Dated March 31, 1993, Approving with Modifications the Settlement Proposal Filed on July 7, 1992, as Revised on September 8, 1992. (Designated in CMS Energy Corporation's and Consumers Power Company's Forms 10-K for the year ended December 31, 1992 as Exhibit (10)(cc).\n(10)(aa) - Unwind Agreement dated as of December 10, 1991 by and among CMS Energy Corporation, Midland Group, Ltd., Consumers Power Company, CMS Midland, Inc., MEC Development Corp. and CMS Midland Holdings Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(y).)\n(10)(bb) - Stipulated AGE Release Amount Payment Agreement dated as of June 1, 1990, among CMS Energy Corporation, Consumers Power Company and The Dow Chemical Company. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(z).)\n(10)(cc) - Parent Guaranty dated as of June 14, 1990 from CMS Energy Corporation to MCV, each of the Owner Trustees, the Indenture Trustees, the Owner Participants and the Initial Purchasers of Senior Bonds in the MCV Sale Leaseback transaction, and MEC Development. (Designated in Consumers Power Company's Form 10-K for the year ended December 31, 1991, File No. 1-5611, as Exhibit (10)(aa).)**\n(11)-(12) - Not applicable.\n(13) - Not Applicable.\n(14)-(20) - Not applicable.\n(21)(a) (CMS ONLY) - Subsidiaries of CMS Energy Corporation.\n(21)(b) - Subsidiaries of Consumers Power Company.\n(22) - Not applicable.\n(23) - Consents of experts and counsel.\n(24) - Powers of Attorney.\n(25)-(28) - Not applicable.\n*Five copies of this exhibit have been signed by, or on behalf of, each of five Owner Participants. With regard to each of the agreements, each copy is substantially identical in all material respects except as to the parties thereto. Therefore, pursuant to Instruction 2, Item 601(a) of Regulation S-K, CMS Energy Corporation and Consumers Power Company are filing a copy of only one such document.\n** Obligations of only CMS Holdings and CMS Midland, second tier subsidiaries of Consumers, and of CMS Energy but not of Consumers.\nExhibits listed above which have heretofore been filed with the Securities and Exchange Commission pursuant to various acts administered by the Commission, and which were designated as noted above, are hereby incorporated herein by reference and made a part hereof with the same effect as if filed herewith.\nIndex to Financial Statement Schedules\nSchedule Page\nV Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 154 Consumers Power Company 157\nVI Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment 1993, 1992 and 1991: CMS Energy Corporation 160 Consumers Power Company 163\nVIII Valuation and Qualifying Accounts and Reserves 1993, 1992 and 1991: CMS Energy Corporation 166 Consumers Power Company 167\nIX Short-Term Borrowings 1993, 1992 and 1991: CMS Energy Corporation 168 Consumers Power Company 169\nX Supplementary Income Statement Information 1993, 1992 and 1991: CMS Energy Corporation 170 Consumers Power Company 171\nReport of Independent Public Accountants CMS Energy Corporation 172 Consumers Power Company 173\nSchedules other than those listed above are omitted because they are either not required, not applicable or the required information is shown in the financial statements or notes thereto.\nColumns omitted from schedules filed have been omitted because the information is not applicable.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo CMS Energy Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CMS Energy Corporation's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nArthur Andersen & Co.\nReport of Independent Public Accountants\nTo Consumers Power Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Consumers Power Company's 1993 Annual Report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 28, 1994. Our audit was made for the purpose of forming an opinion on those basic consolidated financial statements taken as a whole. The schedules listed in Item 14(a) are the responsibility of the Company's management and are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.\nARTHUR ANDERSEN & Co.\nDetroit, Michigan, January 28, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, CMS Energy Corporation has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCMS ENERGY CORPORATION\nBy William T. McCormick, Jr. ---------------------------- William T. McCormick, Jr. Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of CMS Energy Corporation and in the capacities and on the 18th day of March 1994.\nSignature Title - -------------------------------------- -----------------------------------\n(i) Principal executive officer: Chairman of the Board, Chief Executive Officer William T. McCormick, Jr. and Director - ------------------------------------- William T. McCormick, Jr.\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President, Controller P. D. Hopper and Chief Accounting Officer - ------------------------------------- Preston D. Hopper\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n* By Thomas A. McNish ------------------------------- Thomas A. McNish, Attorney-in-Fact\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Consumers Power Company has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 18th day of March 1994.\nCONSUMERS POWER COMPANY\nBy William T. McCormick, Jr. --------------------------------- William T. McCormick, Jr. Chairman of the Board\nPursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of Consumers Power Company and in the capacities and on the 18th day of March 1994.\nSignature Title - ------------------------------------- -----------------------------------\n(i) Principal executive officer:\nPresident and Michael G. Morris Chief Executive Officer - ------------------------------------- Michael G. Morris\n(ii) Principal financial officer:\nSenior Vice President and A M Wright Chief Financial Officer - ------------------------------------- Alan M. Wright\n(iii) Controller or principal accounting officer:\nVice President and Dennis DaPra Controller - ------------------------------------- Dennis DaPra\n(iv) A majority of the Directors including those named above:\nDirector - ------------------------------------- James J. Duderstadt\nSignature Title - ------------------------------------- -----------------------------------\nVictor J. Fryling Director - ------------------------------------- Victor J. Fryling\nEarl D. Holton* Director - ------------------------------------- Earl D. Holton\nLois A. Lund* Director - ------------------------------------- Lois A. Lund\nWilliam T. McCormick, Jr. Director - ------------------------------------- William T. McCormick, Jr.\nFrank H. Merlotti* Director - ------------------------------------- Frank H. Merlotti\nW. U. Parfet* Director - ------------------------------------- William U. Parfet\nPercy A. Pierre* Director - ------------------------------------- Percy A. Pierre\nT. F. Russell* Director - ------------------------------------- Thomas F. Russell\nS. Kinnie Smith, Jr.* Director - ------------------------------------- S. Kinnie Smith, Jr.\nDirector - ------------------------------------- Robert D. Tuttle\nKenneth Whipple* Director - ------------------------------------- Kenneth Whipple\nJohn B. Yasinsky* Director - ------------------------------------- John B. Yasinsky\n*By Thomas A. McNish -------------------------------- Thomas A. McNish, Attorney-in-Fact"},"word_count":{"kind":"number","value":48450,"string":"48,450"},"character_count":{"kind":"number","value":317717,"string":"317,717"}}},{"rowIdx":290,"cells":{"filename":{"kind":"string","value":"1800_1993.txt"},"id":{"kind":"string","value":"1800_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"1800"},"text":{"kind":"string","value":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS\nAbbott Laboratories is an Illinois corporation, incorporated in 1900. The Company's* principal business is the discovery, development, manufacture, and sale of a broad and diversified line of health care products and services.\nFINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS, GEOGRAPHIC AREAS, AND CLASSES OF SIMILAR PRODUCTS\nIncorporated herein by reference is the footnote entitled \"Industry Segment and Geographic Area Information\" of the Consolidated Financial Statements in the Abbott Laboratories Annual Report for the year ended December 31, 1993 (\"1993 Annual Report\"), filed as an exhibit to this report. Also incorporated herein by reference is the text and table of sales by class of similar products included in the section of the 1993 Annual Report captioned \"Financial Review.\"\nNARRATIVE DESCRIPTION OF BUSINESS\nPHARMACEUTICAL AND NUTRITIONAL PRODUCTS\nIncluded in this segment is a broad line of adult and pediatric pharmaceuticals and nutritionals. These products are sold primarily on the prescription or recommendation of physicians or other health care professionals. The segment also includes agricultural and chemical products, bulk pharmaceuticals, and consumer products.\nPrincipal pharmaceutical and nutritional products include the anti-infectives clarithromycin, sold in the United States under the trademark Biaxin-R- and outside the United States primarily under the trademark Klacid-R- and tosufloxacin, sold in Japan under the trademark Tosuxacin-TM-; various forms of the antibiotic erythromycin, sold primarily as PCE-R- or polymer-coated erythromycin, Erythrocin-R-, and E.E.S.-R-; agents for the treatment of epilepsy, including Depakote-R-; a broad line of cardiovascular products, including Loftyl-R-, a vasoactive agent sold outside the United States; Hytrin-R-, used as an anti-hypertensive and for the treatment of benign prostatic hyperplasia; Abbokinase-R-, a thrombolytic drug; Survanta-R-, a bovine derived lung surfactant; various forms of prepared infant formula, including Similac-R-, Isomil-R-, and Alimentum-R-; and other medical and pediatric nutritionals, including Ensure-R-, Ensure Plus-R-, Jevity-R-, Glucerna-R-, Advera-TM-, PediaSure-R-, Pedialyte-R- and Gain-R-. Consumer products include the dandruff shampoo Selsun Blue-R-; Murine-R- eye care and ear care products; Tronolane-R- hemorrhoid medication; and Faultless-R- rubber sundry products. Agricultural and chemical products include plant growth regulators, including ProGibb-R-; herbicides; larvicides, including Vectobac-R-; and biologically derived insecticides, including DiPel-R- and XenTari-R-.\nPharmaceutical and nutritional products are generally sold directly to retailers, wholesalers, health care facilities, and government agencies. In most cases, they are distributed from Company-owned distribution centers or public warehouses. Certain products are co-marketed with other companies. In certain overseas countries, some of these products are marketed and distributed through distributors. Primary marketing efforts for pharmaceutical and nutritional products are directed toward securing the prescription or recommendation of the Company's brand of products by physicians or other health care professionals. Managed care purchasers, for example health maintenance organizations (HMOs) and pharmacy benefit managers, are becoming increasingly important customers. Competition is generally from other broad line and specialized health care manufacturers. A significant aspect of competition is the search for technological innovations. The - ------------------------ * As used throughout the text of this Report, the term \"Company\" refers to Abbott Laboratories, an Illinois corporation, or Abbott Laboratories and its consolidated subsidiaries, as the context requires.\nintroduction of new products by competitors and changes in medical practices and procedures can result in product obsolescence. In addition, the substitution of generic drugs for the brand prescribed has increased competitive pressures on pharmaceutical products.\nConsumer products are promoted directly to the public by consumer advertising. These products are generally sold directly to retailers and wholesalers. Competitive products are sold by other diversified consumer and health care companies. Competitive factors include consumer advertising, scientific innovation, price, and availability of generic product forms.\nAgricultural and chemical products are generally sold to agricultural distributors and pharmaceutical companies. Competition is primarily from large chemical and agricultural companies and companies selling specialized agricultural products. Competition is based on numerous factors depending on the market served. Important competitive factors include product performance for specialized industrial and agricultural uses, price, and technological advantages.\nThe Company is the leading worldwide producer of the antibiotic erythromycin. Similac-R- is the leading infant formula product in the United States.\nUnder an agreement between the Company and Takeda Chemical Industries, Ltd. of Japan (Takeda), TAP Pharmaceuticals Inc. (TAP), owned 50 percent by the Company and 50 percent by Takeda, develops and markets in the United States products based on Takeda research. TAP markets Lupron-R-, an LH-RH analog, and Lupron Depot-R-, a sustained release form of Lupron-R-, in the United States. These agents are used for the treatment of advanced prostatic cancer, endometriosis, and central precocious puberty. The Company also has marketing rights to certain Takeda products in select Latin American markets. The Company also markets Lupron-R-, Lupron Depot-R-, and Lupron Depot-Ped-R- in select markets outside the United States.\nHOSPITAL AND LABORATORY PRODUCTS\nHospital and laboratory products include diagnostic systems for blood banks, hospitals, commercial laboratories, and alternate-care testing sites; intravenous and irrigation fluids and related administration equipment, including electronic drug delivery systems; drugs and drug delivery systems; anesthetics; critical care products; and other medical specialty products for hospitals and alternate-care sites.\nThe principal products included in this segment are parenteral (intravenous or I.V.) solutions and related administration equipment sold as the LifeCare-R- line of products, LifeShield-R- sets, and Venoset-R- products; irrigating fluids; parenteral nutritionals such as Aminosyn-R- and Liposyn-R-; Plum-R- and Omni-Flow-R- electronic drug delivery systems; Abbott Pain Management Provider-R-; patient-controlled analgesia (PCA) systems; venipuncture products; hospital injectables; premixed I.V. drugs in various containers; ADD-Vantage-R- and Nutrimix-R- drug and nutritional delivery systems; anesthetics, including Pentothal-R-, isoflurane, and enflurane; hemodynamic monitoring equipment; Calcijex-R-, an injectable agent for treatment of bone disease in hemodialysis patients; critical care products including Opticath-R-; screening tests for hepatitis B, HTLV-1, hepatitis B core, and hepatitis C; tests for detection of AIDS antibodies and antigens, and other infectious disease detection systems; tests for determining levels of abused drugs with the ADx-R- instrument; physiological diagnostic tests; cancer monitoring tests including tests for prostate specific antigen; laboratory tests and therapeutic drug monitoring systems such as TDx-R-; clinical chemistry systems such as Abbott Spectrum-R-, Abbott Spectrum-R- EPx-R-, Abbott Spectrum-R- CCx-TM-, and Quantum-TM-; Commander-R- and IMx-R- lines of diagnostic instruments and chemical reagents used with immunoassay diagnostics; Abbott Vision-R-, a desk-top blood analyzer, the Abbott TestPack-R- system for diagnostic testing, and a full line of hematology systems and reagents known as the Cell-Dyn-R- series. The hospital and laboratory products the Company expects to introduce in the United States in 1994 include: AxSym-TM-, a diagnostic system; Abbott Maestro-TM-, a data management system; and EnCounter-R-, a desktop hematology analyzer.\nThe Company markets hospital and laboratory products in the United States and many other countries. These products are generally distributed to wholesalers and directly to hospitals, laboratories, and physicians' offices from distribution centers maintained by the Company. Sales are\nalso made in the home infusion services market directly to patients receiving treatment outside the hospital through marketing arrangements with hospitals and other health care providers. Overseas sales are made either directly to customers or through distributors, depending on the market served.\nThe hospital and laboratory products industry segment is highly competitive, both in the United States and overseas. This segment is subject to competition in technological innovation, price, convenience of use, service, instrument warranty provisions, product performance, long-term supply contracts, and product potential for overall cost effectiveness and productivity gains. Products in this segment can be subject to rapid product obsolescence. The Company has benefitted from technological advantages of certain of its current products; however, these advantages may be reduced or eliminated as competitors introduce new products.\nThe Company is one of the leading domestic manufacturers of I.V. and irrigating solutions and related administration equipment, parenteral nutritional products, anesthesia products, and drug delivery systems. It is also the worldwide leader in in vitro diagnostic products, including thyroid tests, therapeutic drug monitoring, cancer monitoring tests, diagnostic tests for the detection of hepatitis and AIDS antibodies, and immunodiagnostic instruments.\nINFORMATION WITH RESPECT TO THE COMPANY'S BUSINESS IN GENERAL\nSOURCES AND AVAILABILITY OF RAW MATERIALS\nThe Company purchases, in the ordinary course of business, necessary raw materials and supplies essential to the Company's operations from numerous suppliers in the United States and overseas. There have been no recent availability problems or significant supply shortages.\nPATENTS, TRADEMARKS, AND LICENSES\nThe Company is aware of the desirability for patent and trademark protection for its products. The Company owns, has applications pending for, and is licensed under a substantial number of patents. Accordingly, where possible, patents and trademarks are sought and obtained for the Company's products in the United States and all countries of major marketing interest to the Company. Principal trademarks and the products they cover are discussed in the Narrative Description of Business on pages 1 and 2. These, and various patents which expire during the period 1994 to 2011, in the aggregate, are believed to be of material importance in the operation of the Company's business. However, the Company believes that no single patent, license, trademark, (or related group of patents, licenses, or trademarks) is material in relation to the Company's business as a whole.\nSEASONAL ASPECTS, CUSTOMERS, BACKLOG, AND RENEGOTIATION\nThere are no significant seasonal aspects to the Company's business. The incidence of certain infectious diseases which occur at various times in different areas of the world does, however, affect the demand for the Company's anti-infective products. Orders for the Company's products are generally filled on a current basis, and order backlog is not material to the Company's business. No single customer accounted for sales equaling 10 percent or more of the Company's consolidated net sales. No material portion of the Company's business is subject to renegotiation of profits or termination of contracts at the election of the government.\nRESEARCH AND DEVELOPMENT\nThe Company spent $880,974,000 in 1993, $772,407,000 in 1992, and $666,336,000 in 1991 on research to discover and develop new products and processes and to improve existing products and processes. The Company continues to concentrate research expenditures in pharmaceutical and diagnostic products.\nENVIRONMENTAL MATTERS\nThe Company believes that its operations comply in all material respects with applicable laws and regulations concerning environmental protection. Regulations under federal and state environmental laws impose stringent limitations on emissions and discharges to the environment from various manufacturing operations. The Company's capital and operating expenditures for pollution control in\n1993 were approximately $32 million and $31 million, respectively. Capital and operating expenditures for pollution control are estimated to approximate $39 million and $36 million, respectively, in 1994.\nThe Company is participating as one of many potentially responsible parties in investigation and/ or remediation at eight locations in the United States and Puerto Rico under the Comprehensive Environmental Response, Compensation, and Liability Act, commonly known as Superfund. The aggregate costs of remediation at these sites by all identified parties are uncertain but have been subject to widely ranging estimates totaling as much as several hundred million dollars. In many cases, the Company believes that the actual costs will be lower than these estimates, and the fraction for which the Company may be responsible is anticipated to be considerably less and will be paid out over a number of years. The Company expects to participate in the investigation or cleanup at these sites. The Company is also voluntarily investigating potential contamination at five Company-owned sites, and has initiated voluntary remediation at four Company-owned sites, in cooperation with the Environmental Protection Agency (EPA) or similar state agencies.\nWhile it is not feasible to predict with certainty the costs related to the previously described investigation and cleanup activities, the Company believes that such costs, together with other expenditures to maintain compliance with applicable laws and regulations concerning environmental protection, should not have a material adverse effect on the Company's earnings or competitive position.\nEMPLOYEES\nThe Company employed 49,659 persons as of December 31, 1993.\nREGULATION\nThe development, manufacture, sale, and distribution of the Company's products are subject to comprehensive government regulation, and the general trend is toward more stringent regulation. Government regulation by various federal, state, and local agencies, which includes detailed inspection of and controls over research and laboratory procedures, clinical investigations, and manufacturing, marketing, sampling, distribution, recordkeeping, storage and disposal practices, substantially increases the time, difficulty, and costs incurred in obtaining and maintaining the approval to market newly developed and existing products. Government regulatory actions can result in the seizure or recall of products, suspension or revocation of the authority necessary for their production and sale, and other civil or criminal sanctions.\nContinuing studies of the utilization, safety, and efficacy of health care products and their components are being conducted by industry, government agencies, and others. Such studies, which employ increasingly sophisticated methods and techniques, can call into question the utilization, safety, and efficacy of previously marketed products and in some cases have resulted, and may in the future result, in the discontinuance of marketing of such products and give rise to claims for damages from persons who believe they have been injured as a result of their use.\nThe cost of human health care products continues to be a subject of investigation and action by governmental agencies, legislative bodies, and private organizations in the United States and other countries. In the United States, most states have enacted generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's version of a pharmaceutical product for the one prescribed. Federal and state governments continue to press efforts to reduce costs of Medicare and Medicaid programs, including restrictions on amounts agencies will reimburse for the use of products. Manufacturers must pay certain statutorily-prescribed rebates on Medicaid purchases for reimbursement on prescription drugs under state Medicaid plans. In addition, the Federal government follows a diagnosis-related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid. The DRG system entitles a health care facility to a fixed reimbursement based on discharge diagnoses rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products. The Veterans Health Care Act of 1992 requires manufacturers to extend\nadditional discounts on pharmaceutical products to various federal agencies, including the Department of Veterans Affairs, Department of Defense, and Public Health Service entities and institutions.\nIn the United States, governmental cost-containment efforts have extended to the federally subsidized Special Supplemental Food Program for Women, Infants, and Children (WIC). All states participate in WIC and have sought and obtained rebates from manufacturers of infant formula whose products are used in the program. All of the states have also conducted competitive bidding for infant formula contracts which require the use of specific infant formula products for the state WIC program. The Child Nutrition and WIC Reauthorization Act of 1989 requires all states participating in WIC to engage in competitive bidding upon the expiration of their existing infant formula contracts.\nGovernmental regulatory agencies now require manufacturers to pay additional fees. Under the Prescription Drug User Fee Act of 1992, the Federal Food and Drug Administration imposes substantial fees on various aspects of the approval, manufacture and sale of prescription drugs. Congress is now considering expanding user fees to medical devices. The Company believes that such legislation, if enacted, will add considerable expense for the Company.\nIn the United States comprehensive legislation has been proposed that would make significant changes to the availability, delivery and payment for healthcare products and services. It is the intent of such proposed legislation to provide health and medical insurance for all United States citizens and to reduce the rate of increases in United States healthcare expenditures. If such legislation is enacted, the Company believes it could have the effect of reducing prices for, or reducing the rate of price increases for health and medical insurance and medical products and services.\nInternational operations are also subject to a significant degree of government regulation. Many countries, directly or indirectly through reimbursement limitations, control the selling price of most health care products. Furthermore, many developing countries limit the importation of raw materials and finished products. International regulations are having an impact on United States regulations, as well. The International Organization for Standardization (\"ISO\") provides the voluntary criteria for regulating medical devices within the European Economic Community. The Food and Drug Administration (\"FDA\") has announced that it will attempt to harmonize its regulation of medical devices with that of the ISO. Recently published changes to the FDA's regulations governing the manufacture of medical devices appear to encompass and exceed the ISO's approach to regulating medical devices. The FDA's adoption of the ISO's approach to regulation and other changes to the manner in which the FDA regulates medical devices will increase the cost of compliance with those regulations.\nEfforts to reduce health care costs are also being made in the private sector. Health care providers have responded by instituting various cost reduction and containment measures.\nIt is not possible to predict the extent to which the Company or the health care industry in general might be affected by the matters discussed above.\nINTERNATIONAL OPERATIONS\nThe Company markets products in approximately 130 countries through affiliates and distributors. Most of the products discussed in the preceding sections of this report are sold outside the United States. In addition, certain products of a local nature and variations of product lines to meet local regulatory requirements and marketing preferences are manufactured and marketed to customers outside the United States. International operations are subject to certain additional risks inherent in conducting business outside the United States, including price and currency exchange controls, changes in currency exchange rates, limitations on foreign participation in local enterprises, expropriation, nationalization, and other governmental action.\nITEM 2.\n\n\nITEM 2. PROPERTIES\nThe Company's corporate offices are located at One Abbott Park Road, Abbott Park, Illinois 60064-3500. The locations of a number of the Company's principal plants are listed below.\nIn addition to the above, the Company has manufacturing facilities in eight other locations in the United States and Puerto Rico. Overseas manufacturing facilities are located in 19 other countries. The Company's facilities are deemed suitable, provide adequate productive capacity, and are utilized at normal and acceptable levels.\nIn the United States and Puerto Rico, the Company owns seven distribution centers. The Company also has twelve United States research and development facilities located at Abbott Park, Illinois; Andover, Massachusetts; Ashland, Ohio; Columbus, Ohio (2 locations); Irving, Texas; Long Grove, Illinois; Madera, California; Mountain View, California; North Chicago, Illinois; Salt Lake City, Utah; and Santa Clara, California. Overseas, the Company has research and development facilities in Argentina, Australia, Canada, Germany, Italy, Japan, The Netherlands, and the United Kingdom.\nThe corporate offices, all manufacturing plants, and all other facilities in the United States and overseas are owned or leased by the Company or subsidiaries of the Company.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various claims and legal proceedings including (as of January 31, 1994) 7 antitrust suits and 6 investigations in connection with the Company's sale and marketing of infant formula products, 138 product liability cases that allege injuries to the offspring of women who ingested a synthetic estrogen (DES) during pregnancy and 22 antitrust suits in connection with the Company's sale and marketing of pharmaceuticals.\nThe infant formula antitrust suits, which are pending in various federal and state courts, allege that the Company conspired with one or more of its competitors to fix prices for infant formula, to rig a bid on a contract to provide infant formula under the federal government's Special Supplemental Food Program for Women, Infants, and Children (WIC), to deprive states of the benefits of competition in providing rebates to the state pursuant to WIC sales, and to restrain trade and monopolize the market for infant formula products in violation of state and federal antitrust laws. The suits were brought on behalf of individuals, a competitor, the Federal Trade Commission, and state governmental agencies seeking treble damages, civil penalties, and other relief. Three of the 7 cases are pending in state courts in Calhoun County and Shelby County, Alabama and in Austin, Texas. The Calhoun County suit purports to be a class action on behalf of Alabama consumers. The 4 other cases are pending in federal courts in Los Angeles, California, Tallahassee, Florida, Baton Rouge, Louisiana (this suit purports to be a class action on behalf of Louisiana consumers), and Washington, D.C. The Company has filed responses to the complaints denying all substantive allegations. The investigations are being conducted by the Attorneys General of the states of California, Connecticut, New York, Pennsylvania and Wisconsin and by the Canadian Bureau of Competition Policy. The four shareholder derivative suits (which were consolidated in federal court in Chicago, Illinois) that had been filed against certain of the Company's officers and directors regarding the Company's sale and marketing of infant formula products were dismissed with prejudice on January 31, 1994.\nTwelve of the 22 pharmaceutical antitrust suits are pending in the United States District Court for the Southern District of New York; 4 are pending in state court in San Francisco County, California; the 6 remaining cases are pending in federal district courts in San Francisco, California, Savannah, Georgia, Minneapolis, Minnesota, Charleston, South Carolina, Austin, Texas, and Galveston, Texas. These suits allege that various pharmaceutical manufacturers have conspired to fix drug prices and/or to discriminate in pricing to retail pharmacies by providing discounts to mail-order pharmacies, institutional pharmacies, and HMOs. The suits were brought on behalf of retail pharmacies, seek treble damages and other relief, and some purport to be class actions. The Company intends to respond to the complaints denying all substantive allegations.\nWhile it is not feasible to predict the outcome of such pending claims, proceedings, and investigations with certainty, management is of the opinion, with which its General Counsel concurs, that their ultimate disposition should not have a material adverse effect on the Company's financial position.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nOfficers of the Company are elected annually by the board of directors at the first meeting held after the annual shareholders meeting. Each officer holds office until a successor has been duly elected and qualified or until the officer's death, resignation, or removal. Vacancies may be filled at any meeting of the board. Any officer may be removed by the board of directors when, in its judgment, removal would serve the best interests of the Company.\nCurrent corporate officers, and their ages as of February 11, 1994, are listed below. The officers' principal occupations and employment from January 1989 to present and the dates of their first\nelection as officers of the Company are also shown. Unless otherwise stated, employment was by the Company for the period indicated. There are no family relationships between any corporate officers or directors.\nDUANE L. BURNHAM**, 52\n1989 -- Vice Chairman and Chief Financial Officer, and Director. 1989 to 1990 -- Vice Chairman and Chief Executive Officer, and Director. 1990 to present -- Chairman of the Board and Chief Executive Officer, and Director. Elected Corporate Officer -- 1982.\nTHOMAS R. HODGSON**, 52\n1989 to 1990 -- Executive Vice President and Director. 1990 to present -- President and Chief Operating Officer, and Director. Elected Corporate Officer -- 1980.\nROBERT N. BECK**, 53\n1989 to 1992 -- Executive Vice President, BankAmerica and Bank of America. 1992 to present -- Senior Vice President, Human Resources. Elected Corporate Officer -- 1992.\nPAUL N. CLARK**, 47\n1989 to 1990 -- Vice President, Pharmaceutical Operations. 1990 to present -- Senior Vice President, Pharmaceutical Operations. Elected Corporate Officer -- 1985.\nGARY P. COUGHLAN**, 49\n1989 -- Senior Vice President and Chief Financial Officer, Kraft, Inc. 1989 to 1990 -- Senior Vice President, Finance, Kraft General Foods. 1990 to present -- Senior Vice President, Finance and Chief Financial Officer. Elected Corporate Officer -- 1990.\nLAEL F. JOHNSON**, 56\n1989 -- Vice President, Secretary and General Counsel. 1989 to present -- Senior Vice President, Secretary and General Counsel. Elected Corporate Officer -- 1981.\nJOHN G. KRINGEL**, 54\n1989 to 1990 -- Vice President, Hospital Products. 1990 to present -- Senior Vice President, Hospital Products. Elected Corporate Officer -- 1981.\nJ. DUNCAN MCINTYRE**, 56\n1989 to 1990 -- Vice President. 1990 to present -- Senior Vice President, International Operations. Elected Corporate Officer -- 1987.\nTHOMAS M. MCNALLY**, 46\n1989 -- Area Vice President, Pacific, Asia and Africa, Abbott International, Ltd. (a subsidiary of the Company). 1989 to 1990 -- Vice President, Chemical and Agricultural Products. 1990 to 1993 -- Senior Vice President, Chemical and Agricultural Products. 1993 to present -- Senior Vice President, Ross Products. Elected Corporate Officer -- 1989.\nROBERT L. PARKINSON, JR.**, 43\n1989 -- Divisional Vice President, Commercial Operations. 1989 to 1990 -- Vice President, Corporate Hospital Marketing. 1990 to 1993 -- Vice President, European Operations.\n1993 to present -- Senior Vice President, Chemical and Agricultural Products. Elected Corporate Officer -- 1989.\nDAVID A. THOMPSON**, 52\n1989 to 1990 -- Vice President, Diagnostic Operations. 1990 to present -- Senior Vice President, Diagnostic Operations. Elected Corporate Officer -- 1982.\nJOY A. AMUNDSON**, 39\n1989 to 1990 -- General Manager, Alternate Site. 1990 -- Divisional Vice President and General Manager, Hospital Products Business Sector. 1990 to 1994 -- Vice President, Corporate Hospital Marketing. 1994 to present -- Vice President, Health Systems. Elected Corporate Officer -- 1990.\nCHRISTOPHER B. BEGLEY, 41\n1989 -- Director, Hospital Products Business Sector. 1989 to 1990 -- General Manager, Hospital Products Business Sector. 1990 to 1993 -- Divisional Vice President and General Manager, Hospital Products Business Sector. 1993 -- Vice President, Hospital Products Business Sector. Elected Corporate Officer -- 1993.\nTHOMAS D. BROWN, 45\n1989 to 1992 -- Divisional Vice President, Western Hemisphere. 1992 to 1993 -- Divisional Vice President, Diagnostic Commercial Operations. 1993 to present -- Vice President, Diagnostic Commercial Operations. Elected Corporate Officer -- 1993.\nGARY R. BYERS**, 52\n1989 to 1993 -- Divisional Vice President, Corporate Auditing. 1993 to present -- Vice President, Internal Audit. Elected Corporate Officer -- 1993.\nKENNETH W. FARMER**, 48\n1989 -- Vice President, Management Information Services. 1989 to present -- Vice President, Management Information Services and Administration. Elected Corporate Officer -- 1985.\nTHOMAS C. FREYMAN**, 39\n1989 to 1991 -- Treasurer, Abbott International, Ltd. (a subsidiary of the Company). 1991 to present -- Vice President and Treasurer. Elected Corporate Officer -- 1991.\nJAY B. JOHNSTON, 50\n1989 to 1992 -- President, Dainabot Co., Ltd. (an affiliate of the Company) and General Manager Asia Pacific, Abbott Diagnostics Division. 1992 -- Divisional Vice President, Business Development. 1992 to 1993 -- Divisional Vice President and General Manager, Diagnostic Assays and Operations. 1993 to present -- Corporate Vice President, Diagnostic Assays and Operations. Elected Corporate Officer -- 1993.\nJAMES J. KOZIARZ, 44\n1989 to 1990 -- General Manager, Hepatitis/Retrovirus Business Sector. 1990 to 1992 -- Vice President and General Manager, Diagnostic Assays. 1992 to present -- Vice President, Diagnostic Products Research and Development. Elected Corporate Officer -- 1993.\nCHRISTOPHER A. KUEBLER, 40\n1989 to 1992 -- Divisional Vice President, Marketing. 1992 to 1993 -- Divisional Vice President, Sales and Marketing. 1993 to present -- Vice President, European Operations. Elected Corporate Officer -- 1993.\nJOHN F. LUSSEN**, 52\n1989 to present -- Vice President, Taxes. Elected Corporate Officer -- 1985.\nDAVID V. MILLIGAN, PH.D., 53\n1989 to 1992 -- Vice President, Diagnostic Products Research and Development. 1992 to present -- Vice President, Pharmaceutical Products Research and Development. Elected Corporate Officer -- 1984.\nRICHARD H. MOREHEAD**, 59\n1989 to present -- Vice President, Corporate Planning and Development. Elected Corporate Officer -- 1985.\nTHEODORE A. OLSON**, 55\n1989 to present -- Vice President and Controller. Elected Corporate Officer -- 1988.\nCARL A. SPALDING, 48\n1989 to 1992 -- Vice President, International, Johnson & Johnson. 1992 to present -- Vice President, General Manager, Ross Products. Elected Corporate Officer -- 1993.\nWILLIAM H. STADTLANDER, 48\n1989 to 1992 -- Divisional Vice President, Medical Nutritionals. 1992 to present -- Divisional Vice President and General Manager, Medical Nutritionals. Elected Corporate Officer -- 1993.\nDANIEL O. STRUBLE**, 53\n1989 to present -- Vice President, Corporate Engineering. Elected Corporate Officer -- 1987.\nELLEN M. WALVOORD**, 54\n1989 to 1991 -- Director, Corporate Communications. 1991 -- Vice President, Investor Relations. 1991 to present -- Vice President, Investor Relations and Public Affairs. Elected Corporate Officer -- 1991.\nJOSEF WENDLER, 44\n1989 to 1990 -- General Manager, Austria & Switzerland. 1990 to 1992 -- Regional Director, Europe, Diagnostic Division. 1992 to 1993 -- Divisional Vice President, Pacific, Asia, Africa. 1993 to present -- Vice President, Pacific/ Asia /Africa Operations. Elected Corporate Officer -- 1993.\nMILES D. WHITE, 38\n1989 to 1990 -- Director of Marketing for the U.S., Abbott Diagnostics Division. 1990 -- Business Unit General Manager, Physiological Diagnostics, Abbott Diagnostics Division and Business Unit General Manager, Cancer Diagnostics. 1990 to 1992 -- Divisional Vice President and General Manager, Hospital Laboratory Sector. 1992 to 1993 -- Divisional Vice President and General Manager, Diagnostic Systems and Operations. 1993 to present -- Vice President, Diagnostic Systems and Operations. Elected Corporate Officer -- 1993.\nDON G. WRIGHT**, 51\n1989 to present -- Vice President, Corporate Quality Assurance and Regulatory Affairs. Elected Corporate Officer -- 1988.\n- ------------------------ ** Pursuant to Item 401(b) of Regulation S-K the Company has identified these persons as \"executive officers\" within the meaning of Item 401(b).\nPART II\nITEM 5.\nITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPRINCIPAL MARKET\nThe principal market for the Company's common shares is the New York Stock Exchange. Shares are also listed on the Chicago and Pacific Stock Exchanges and are traded on the Boston, Cincinnati, and Philadelphia Exchanges. Overseas, the Company's shares are listed on the London Stock Exchange, Tokyo Stock Exchange, and the Swiss Stock Exchanges of Zurich, Basel, Geneva, and Lausanne.\nMarket prices are as reported by the New York Stock Exchange composite transaction reporting system.\nSHAREHOLDERS\nThere were 82,947 shareholders of record of Abbott common shares as of December 31, 1993.\nDIVIDENDS\nQuarterly dividends of $.17 per share and $.15 per share were declared on common shares in 1993 and 1992, respectively after reflecting the May 29, 1992 stock split.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nIncorporated herein by reference for the years 1989 through 1993 are the applicable portions of the section captioned \"Summary of Selected Financial Data\" of the 1993 Annual Report.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated herein by reference is management's discussion and analysis of financial condition and results of operations for the years 1993, 1992, and 1991 found under the section captioned \"Financial Review\" of the 1993 Annual Report.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated herein by reference are the portions of the 1993 Annual Report captioned Consolidated Balance Sheet, Consolidated Statement of Income, Consolidated Statement of Cash Flows, Consolidated Statement of Shareholders' Investment, Notes to Consolidated Financial Statements and Report of Independent Public Accountants (which contains the related report of Arthur Andersen & Co. dated January 14, 1994). Data relating to quarterly interim results is found in Note 8.\nITEM 9.\nITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated herein by reference are \"Information Concerning Nominees for Directors\" and \"Compliance with Section 16(a) of The Securities Exchange Act of 1934\" found in the 1994 Abbott Laboratories Proxy Statement (\"1994 Proxy Statement\"), which will be filed with the Commission on or about March 4, 1994.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nThe material in the 1994 Proxy Statement under the heading \"Executive Compensation,\" other than the Report of the Compensation Committee and the Performance Graph, are hereby incorporated by reference.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference is the text found under the caption \"Information Concerning Security Ownership\" in the 1994 Proxy Statement.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference is that portion of the 1994 Proxy Statement under the caption \"Compensation Committee Interlocks and Insider Participation.\"\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) DOCUMENTS FILED AS PART OF THIS FORM 10-K.\n1. FINANCIAL STATEMENTS: The Consolidated Financial Statements for the years ended December 31, 1993, 1992, and 1991 and the related report of Arthur Andersen & Co. dated January 14, 1994 appearing under the portions of the 1993 Annual Report captioned Consolidated Balance Sheet, Consolidated Statement of Earnings, Consolidated Statement of Cash Flows, Consolidated Statement of Shareholders' Investment, Notes to Consolidated Financial Statements and Report of Independent Public Accountants, respectively, are incorporated by reference in response to Item 14(a)1. With the exception of the portions of the 1993 Annual Report specifically incorporated herein by reference, such Report shall not be deemed filed as part of this Annual Report on Form 10-K or otherwise deemed subject to the liabilities of Section 18 of the Securities Exchange Act of 1934.\n2. FINANCIAL STATEMENT SCHEDULES: The required financial statement schedules are found on the pages indicated below. These schedules should be read in conjunction with the Consolidated Financial Statements in the 1993 Annual Report:\n3. EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K: The information called for by this paragraph is incorporated herein by reference to the Exhibit Index on pages 16 and 17 of this Form 10-K.\n(b) REPORTS ON FORM 8-K DURING THE QUARTER ENDED DECEMBER 31, 1993:\nNo reports on Form 8-K were filed during the quarter ended December 31, 1993.\n(c) EXHIBITS FILED (SEE EXHIBIT INDEX ON PAGES 16 AND 17).\n(D) FINANCIAL STATEMENT SCHEDULES FILED (SEE PAGES 18 THROUGH 23).\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Abbott Laboratories has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nABBOTT LABORATORIES\nBy /s/ DUANE L. BURNHAM Duane L. Burnham Chairman of the Board and Chief Executive Officer\nDate: February 11, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Abbott Laboratories and in the capacities and on the dates indicated:\n/s/ DUANE L. BURNHAM Duane L. Burnham Chairman of the Board, Chief Executive Officer, and Director of Abbott Laboratories (principal executive officer) Date: February 11, 1994\n/s/ GARY P. COUGHLAN Gary P. Coughlan Senior Vice President, Finance and Chief Financial Officer (principal financial officer) Date: February 11, 1994\n/s/ THOMAS R. HODGSON Thomas R. Hodgson President, Chief Operating Officer, and Director of Abbott Laboratories Date: February 11, 1994\n/s/ THEODORE A. OLSON Theodore A. Olson Vice President and Controller (principal accounting officer) Date: February 11, 1994\n/s/ K. FRANK AUSTEN K. Frank Austen, M.D. Director of Abbott Laboratories Date: February 11, 1994\n/s/ H. LAURANCE FULLER H. Laurance Fuller Director of Abbott Laboratories Date: February 11, 1994\n/s/ BERNARD J. HAYHOE Bernard J. Hayhoe Director of Abbott Laboratories Date: February 11, 1994\n/s/ ALLEN F. JACOBSON Allen F. Jacobson Director of Abbot Laboratories Date: February 11, 1994\n/s/ DAVID A. JONES David A. Jones Director of Abbott Laboratories Date: February 11, 1994\n/s/ BOONE POWELL, JR. Boone Powell, Jr. Director of Abbott Laboratories Date: February 11, 1994\n/s/ A. BARRY RAND A. Barry Rand Director of Abbott Laboratories Date: February 11, 1994\n/s/ W. ANN REYNOLDS W. Ann Reynolds Director of Abbott Laboratories Date: February 11, 1994\n/s/ WILLIAM D. SMITHBURG William D. Smithburg Director of Abbott Laboratories Date: February 11, 1994\n/s/ JOHN R. WALTER John R. Walter Director of Abbott Laboratories Date: February 11, 1994\n/s/ WILLIAM L. WEISS William L. Weiss Director of Abbott Laboratories Date: February 11, 1994\nEXHIBIT INDEX ABBOTT LABORATORIES ANNUAL REPORT FORM 10-K\n- --------- * Incorporated herein by reference.\nThe Company will furnish copies of any of the above exhibits to a shareholder upon written request to the Corporate Secretary, Abbott Laboratories, One Abbott Park Road, Abbott Park, Illinois 60064-3500.\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE I--INVESTMENT SECURITIES MATURING AFTER ONE YEAR DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE V--PROPERTY AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE VIII--VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 (DOLLARS IN THOUSANDS)\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE IX SHORT-TERM BORROWINGS FOR THE YEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (DOLLARS IN THOUSANDS)\nABBOTT LABORATORIES AND SUBSIDIARIES SCHEDULE X-SUPPLEMENTARY CONSOLIDATED STATEMENT OF EARNINGS INFORMATION FOR THE YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991 (DOLLARS IN THOUSANDS)"},"word_count":{"kind":"number","value":6121,"string":"6,121"},"character_count":{"kind":"number","value":42451,"string":"42,451"}}},{"rowIdx":291,"cells":{"filename":{"kind":"string","value":"20762_1993.txt"},"id":{"kind":"string","value":"20762_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"20762"},"text":{"kind":"string","value":"ITEM 1 AND 2. BUSINESS; PROPERTIES\nClark Refining & Marketing, Inc. (formerly known as Clark Oil & Refining Corporation), a Delaware Corporation (the \"Company\" or \"Clark\"), headquartered in St. Louis, Missouri, is one of the leading independent refiners and marketers of petroleum products in the Midwest. Its principal activities consist of crude oil refining, wholesale marketing of refined petroleum products and retail marketing of gasoline and convenience products. These businesses have been operating under the Clark brand name for over 60 years.\nThe assets related to Clark's business were acquired on November 22, 1988 (the \"Acquisition\") out of bankruptcy proceedings. The assets acquired consisted of (i) substantially all of the assets of Apex Oil Company, Inc., a Wisconsin corporation (formerly known as OC Oil & Refining Corporation and prior thereto known as Clark Oil & Refining Corporation, a Wisconsin corporation (\"Old Clark\")) and its subsidiaries and (ii) certain other assets and liabilities of the Novelly/Goldstein Partnership (formerly known as Apex Oil Company), a Missouri general partnership (\"Apex\"), the indirect owner of Old Clark.\nAll of the outstanding common stock of Clark is owned by Clark R & M Holdings, Inc., a Delaware corporation (\"R & M Holdings\"), an indirect wholly- owned subsidiary of The Horsham Corporation (\"Horsham\"), a Quebec corporation. Horsham acquired an initial 60% ownership in R & M Holdings at the Acquisition and 100% ownership in December 1992. Horsham is a Canadian management and holding company which also owns a controlling 20% interest in American Barrick Resources Corporation (\"Barrick\"), a major gold mining company and 100% of Horsham Properties GmbH which is developing a 600-acre business park near Berlin, Germany. Peter Munk, Horsham's Chairman and Chief Executive Officer and controlling shareholder, is Chairman of the Board and a Director of Clark.\nINDUSTRY ENVIRONMENT\nDuring the period from 1982 to 1993, domestic refining capacity declined by 15.1% from 17.9 million bbls/day to 15.2 million bbls/day due primarily to a significant reduction in the total number of domestic refineries. During the same period, refinery throughput, or production, grew in response to market demand, from 11.8 million bbls/day to 13.9 million bbls/day principally due to increases in the number of operating vehicles and passenger miles driven. Refining capacity utilization grew from 65.8% in 1982 to 91.4% in 1993. Clark believes that the maximum achievable refining utilization for the industry is approximately 93%, because of the requirements for scheduled and unscheduled maintenance shutdowns. The following table sets forth selected US refinery industry information published by the US Energy Information Administration:\nSELECTED UNITED STATES REFINING INDUSTRY STATISTICS\n- -------- *1993 figures have been obtained from the American Petroleum Institute.\nClark believes that US refining capacity will continue to decline due to a continuing escalation in the cost of new refinery construction combined with the high cost of bringing many older refineries into compliance with current and proposed environmental regulations, such as those mandated by the Clean Air Act. The Clean Air Act Amendments of 1990 provide, among other things, that (i) as of November 1992, the 39 cities which had failed to attain mandated carbon monoxide air quality standards were required to use\noxygenated gasoline for four to twelve months of each year depending upon each area's historical noncompliance period and (ii) beginning in 1995, the nine cities which have the worst ozone quality, including the Chicago and Milwaukee metropolitan areas, will be required to use, and another 87 areas which have failed to attain ozone air quality standards may elect to use, \"reformulated\" gasoline throughout the year in order to decrease the emission of hydrocarbons and toxic pollutants. Because of the expenditures associated with producing reformulated gasoline and compliance with the Clean Air Act and other environmental regulations, various US refiners have announced that they will sell and or close those refineries where capital expenditures needed to ensure compliance would not be economic. Over the near term, many refiners are expected to utilize their capital expenditure budgets to bring their facilities into compliance with environmental requirements, rather than to add to crude oil throughput capacity. Refining and marketing is a cyclical commodity-based business in which individual participants have virtually no control over industry margin levels.\nBUSINESS STRATEGY\nClark's strategic business plan is to position Clark as a low-cost, high- quality refiner and marketer of refined petroleum products. Clark plans to build on its strengths, which include flexibility in feedstock supply and refined product output, a strong integrated wholesale distribution network, a strong retail presence founded in Clark brand name recognition, comprehensive planning and budgeting systems, strong entrepreneurial leadership and a high level of employee participation. Clark is seeking to position itself so that cash flow remains positive even in the worst possible industry margin environment. The refining and marketing industry is mature, highly competitive and extremely capital intensive. However, a highly productive company--in terms of both operational excellence and capital utilization--can produce superior results for its stakeholders. Management believes that there are four critical strategies to achieve these goals:\n. IMPROVE PRODUCTIVITY OF EXISTING OPERATIONS--Clark's refineries are in the lower half of industry productivity benchmarks, providing much opportunity for improvement. On the retail side, Clark's people and assets have been neglected for many years while competitors have invested heavily in upgrading and expanding their facilities. However, Clark's investment and operating cost of a typical store are substantially lower than most of its competitors--a significant competitive advantage. In 1993, Clark set a goal to achieve pre-tax productivity gains of $75 million. This goal assumes no improvement in industry margins and despite deterioration in these margins in 1993, an estimated gain of $20 million was realized in the last half of the year.\n. MINIMIZE CAPITAL INVESTMENT--Clark plans to tie capital spending to cash flow generated. Where alternative product markets exist under environmental regulations, Clark intends to base capital investment decisions on economic returns.\n. CULTURE--Clark believes that it is people, not assets, that make the difference in the success of the organization. The Company is striving to achieve a highly motivated, entrepreneurial workforce where its people understand the goals, objectives and targets of the Company, have the freedom to contribute to the best of their abilities and participate in the organization's success.\n. GROWTH--Clark plans to grow its retail and refining business through acquisition to benefit from the operating, capital and market synergies associated with greater mass, particularly within current markets.\nRETAIL DIVISION\nThe Clark retail system began operations during the 1930s with the opening of Old Clark's first store in Milwaukee, Wisconsin and expanded thereafter to Missouri and Illinois and then throughout the Midwest. At its peak in the early 1970s, Old Clark operated more than 1,800 retail stores and had established a strong market presence for high octane gasoline at discount prices. In subsequent years, Old Clark, in line with the general industry trend, rationalized its operating stores, closing down marginal locations.\nDuring the 1970s, the majority of stores were dealer-operated. However, to ensure more direct control of its marketing and distribution network, Old Clark assumed management of most of its stores from 1973 through 1983. The high proportion of company-operated stores enables Clark to respond more quickly and uniformly to changing market conditions than major oil companies which generally have most of their stores operated by independent dealers or jobbers. This control over retail operations, combined with its over 60 year history and brand strength throughout the Midwest, gives Clark a unique competitive advantage. Clark has initiated an enhancement program aimed at increasing sales volumes and profits while focusing on return on investment. The program is designed to position Clark as the premier value-oriented gasoline marketer in the Midwest.\nClark is reviewing its stores and markets and has developed a long-term retail strategy to capitalize on its over 60 year old franchise, reputation for quality products and efficient distribution network. Recognition of the Clark name may be enhanced by improving the image of the entire network, through superior customer service, graphic reimaging, building improvements and strengthened advertising. Management has adopted \"Market Business Planning\" principles that define preferred markets by developing a market ranking for existing and potential investment opportunities. These techniques combine economic, demographic and market data to arrive at market specific plans that assist in both asset and operational strategies. The Company plans to focus on those core markets where Clark has, or can develop, a competitive advantage. Clark will consider expanding through development and acquisition of stores in those markets where Clark already has a competitive strength on which to build or where similar opportunities have been identified. In those market areas where the Clark brand name is not strong and Clark has a low market ranking, Clark will divest retail locations if favorable sale opportunities arise.\nClark classifies its stores into four categories: basic, upgraded, minimart and \"On The Go\". A basic store is essentially a store as originally built in the 1950s and 1960s and consists of a small kiosk-style building (generally less than 400 total square feet and 200 square feet of selling area) with two to four \"islands\" for pumps. Since 1988, Clark has invested in upgrading and rebuilding selected sites. An upgraded store configuration generally consists of the basic format with the addition of a canopy and other minor cosmetic improvements. Most upgraded stores include the installation of new blending pumps and at many locations existing storage tanks have been replaced. A minimart is an upgraded location where the kiosk-style building has been replaced with a convenience store of at least 900 square feet. In 1992, Clark implemented a strategic enhancement program under which stores in preferred market areas will undergo a sales optimization program to modestly increase the sales area to 400 sq. ft. to emphasize quick and convenient purchasing of gasoline and \"On The Go\" convenience items. This strategy attempts to differentiate Clark stores from (i) major oil company outlets, which typically price gasoline at a higher level, (ii) the convenience store industry, which offers a full range of grocery items in addition to gasoline and (iii) low price independents, whose gasoline quality may be perceived to be inferior.\nClark estimates that previously upgraded locations will require an additional investment of approximately $70,000 per site to incorporate this \"On The Go\" theme and that non-upgraded locations will require approximately $160,000 per site. The Company believes that these investments are significantly less expensive than investments made by competitors for similar upgrading. Emphasis will be placed on the sale of select high volume convenience products without competing directly with the larger convenience store (\"C-Store\") format of major oil companies or other full scale C-Stores. Market research conducted in the fourth quarter of 1992 indicated that gasoline customers are more likely to shop at Clark if store sizes are increased. Furthermore, Clark believes its existing customers are likely to shop more often and are more likely to purchase additional convenience products from larger stores. Virtually all the basic stores have the physical characteristics permitting them to be converted to the \"On The Go\" format.\nThe volume per store varies significantly, depending upon location, competition, type and quality of the store improvements. The configuration of the stores was as follows:\nAs of December 31, 1993, Clark had 846 retail stores located in 12 midwestern states, all of which operated under the Clark trade name. Of these 846 stores (of which 763 are owned and 83 are leased), Clark directly operated 836 and the reminder were dealer operated. Virtually all stores were self-service and all sold convenience products.\nStore locations are geographically diverse. More than half the stores are in suburban areas, with the balance approximately equally divided between urban and rural areas. The geographic distribution of retail stores by state as of December 31, 1993, was as follows:\nGEOGRAPHICAL DISTRIBUTION OF RETAIL STORES\nClark began marketing three grades of gasoline in 1989 with the introduction of special blending dispenser pumps. These pumps enable Clark to improve volumes and margins by marketing a more profitable mid-grade of gasoline without installation of costly additional underground storage tanks. Approximately one-half of Clark's stores now have blending pumps. Management currently expects that by the end of 1995, canopies will have been installed over the pump islands at all of Clark's stores. Management believes that the installation of canopies will improve gasoline sales volume due to the shelter provided from weather conditions.\nUntil early 1989, retail sales were primarily for cash as customers were charged extra for credit card purchases. In 1989, Clark upgraded its credit card processing system, enabling it to receive payments for credit card sales within 48 hours. Simultaneously, to remain competitive, Clark revised its pricing policy to charge the same price for cash and credit card purchases. In late 1989, a business fleet card program was initiated to attract a new segment of customers. Fleet customers are provided with a proprietary credit card and detailed vehicle statistical information which is included on a convenient monthly invoice.\nClark has implemented a number of environmental projects at its retail stores. These projects include the ongoing Clark response to the September 1988 regulations concerning the design, construction, installation, repair and testing of underground storage tanks and the requirement of the Clean Air Act to install Stage II vapor recovery systems at certain retail stores.\nREFINING DIVISION\nThe refining division consists of two refineries in Illinois: Blue Island near Chicago and Hartford near St. Louis, Missouri. The refining division also includes Clark's supply and distribution and wholesale operations. Based upon Clark's current cost structure and business plans, Clark anticipates that it will continue to operate the Blue Island and Hartford refineries at or near their respective full-rated capacities of approximately 70,000 and 60,000 barrels of crude oil per stream day.\nEach refinery specializes in processing different types of crude oil feedstocks, although both operations are sufficiently flexible to process a variety of crude oils. Clark's refineries are capable of producing a complementary product range, as well as shifting production quickly to take advantage of market opportunities as they arise. Clark employs sophisticated linear programming techniques to optimize the operations of both refineries. These techniques enable Clark to predict feedstock performance, select optimal feedstock combinations and produce the most advantageous refined product mix for a given set of market conditions. Feedstock flexibility and linear programs thus enable Clark to take advantage of lower cost crudes and to adjust the output mix in response to changing market prices at any given time. These refineries compare favorably in the amount of light oil products produced per barrel of crude oil and therefore in competitiveness, with major oil company refineries in their market areas.\nIn addition to gasoline, Clark's refineries produce other types of refined products. Number 2 diesel fuel is used mainly as a fuel for diesel burning engines. Number 2 diesel fuel production is moved via pipeline or barge to Clark's 14 product terminals to be sold over Clark's terminal truck racks or sold via refinery pipeline or barge movement. Other production includes residual oils (slurry oil and vacuum tower bottoms) which are used mainly for heavy industrial fuel (e.g., power generation) and in the manufacturing of roofing shingles or for asphalt used in highway paving.\nIn the Clean Air Act Amendments of 1990, the US Environmental Protection Agency (\"EPA\") promulgated regulations mandating maximum sulfur content for diesel fuel offered for sale for on-road consumption beginning in October 1993. Additional EPA regulations include guidelines for reformulated gasoline to be effective by 1995 for nine regions in the US, including the Chicago and Milwaukee metropolitan areas. These regulations are expected to be expanded to most major urban centers by the year 2000. See \"Regulatory Matters.\" Clark, and virtually all other domestic refineries producing gasoline, will be required to make significant capital expenditures to comply with these new requirements.\nOver the period 1994 to 1998, Clark has preliminary plans to complete a number of environmental and other regulatory capital expenditure programs. These environmental expenditures comprise two major categories, those that are mandatory in order to comply with regulations pertaining to ground, water and air contamination and those that are primarily discretionary involving the reformulation of refined fuel for sale into certain defined markets. The total mandatory expenditures for regulatory compliance over the next five years are estimated at approximately $100 million, split evenly between the retail and refining businesses. Costs of potential future regulations cannot be forecast.\nThe expenditures required to comply with reformulated fuels regulations are primarily discretionary, subject to market conditions and economic justification. The reformulated fuels programs impose restrictions on properties of fuels to be refined and marketed, including those pertaining to gasoline volatility, oxygenated fuel, detergent addition and sulfur content. The regulations regarding these fuel properties apply to different markets in which Clark operates, in certain circumstances at different times of the year.\nModifications estimated at $10-15 million to produce reformulated gasoline are being considered for the Blue Island refinery. The decision to proceed with such a project will depend on economic justification. A project initiated to produce low sulfur diesel fuel at the Hartford refinery was delayed in 1992 based on internal and third party analyses that indicated an oversupply of low sulfur diesel fuel capacity in Clark's marketplace. These analyses projected relatively narrow price differentials between low and high sulfur diesel\nproducts which have thus far borne out after the initial transition to the low sulfur regulations. However, if price differentials widen sufficiently to justify investment, Clark could install the necessary equipment over a 14 to 16 month period at an estimated additional cost of $40 million. Furthermore, if Clark decided to install equipment necessary to produce reformulated gasoline and control sulfur emissions at Hartford, the gasoil desulfurizer and related equipment are estimated to cost an additional $90-130 million. These estimates have declined from a year ago as Clark has found more cost-effective methods of complying with the regulations.\nBlue Island Refinery\nThe Blue Island refinery is located in Blue Island, Illinois, approximately 17 miles south of Chicago. The refinery is situated on a 170-acre site, bounded by the town of Blue Island and the Calumet-Sag Canal. The facility was initially constructed in 1945 and, through a series of improvements and expansions, has reached a crude oil capacity of 70,000 barrels per stream day. The Blue Island refinery has a Nelson Complexity Rating of 8.78 versus an average rating of 8.61 for all Petroleum Administration for Defense District (\"PADD\") II refineries. The Nelson Complexity rating is an industry measure of a refinery's ability to produce higher value-added products. Blue Island has among the highest capabilities to produce gasoline relative to the other refineries in its market area. During most of the year, gasoline is the most profitable refinery product.\nThe production of the Blue Island refinery was as follows:\nBLUE ISLAND REFINERY PRODUCTION YIELD (BARRELS IN THOUSANDS)\n- -------- (a) Refinery utilization is production yield relative to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases) which add to the refinery's output are utilized in the refining process. (b) Refinery utilization reflects 1993 maintenance turnaround downtime of approximately two months on selected units. A \"maintenance turnaround\" is a periodically required standard procedure for refurbishing and maintenance of a refinery that is scheduled approximately every three years. During a turnaround, which usually lasts approximately four to six weeks, refinery production is reduced significantly.\nHartford Refinery\nThe Hartford refinery is located in Hartford, Illinois, approximately 17 miles northeast of St. Louis, Missouri. The refinery is situated on a 400-acre site. The facility was initially constructed in 1941 and, through\na series of improvements and expansions, has reached a crude oil refining capacity of approximately 60,000 barrels per stream day. The Hartford refinery has a Nelson Complexity Rating of 9.83 versus an average of 8.61 for all PADD II refineries. The Hartford facility has the ability to process lower cost, heavy, high-sulfur crude oil into higher value products such as gasoline. This upgrading capability allows the refinery to produce a high mix of premium products and permits Clark to benefit from higher margins when high sulfur crude oil, such as Maya crude oil, is available at a significant discount to low sulfur crude oil.\nThe production of the Hartford refinery was as follows:\nHARTFORD REFINERY PRODUCTION YIELD (BARRELS IN THOUSANDS)\n- -------- (a) Refinery utilization is production yield relative to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases) which add to the refinery's output are utilized in the refining process. (b) Refinery utilization reflects 1991 maintenance turnaround downtime of approximately two months on selected units.\nSupply\nClark's integrated refining and marketing assets are strategically located in the Midwest in close proximity to a variety of supply and distribution channels. As a result, Clark has the flexibility to acquire crude oil from a variety of sources around the world and the ability to distribute its products to its own retail system and to most wholesale markets.\nClark's refineries are located on major inland water transportation routes and are connected to various regional, national and Canadian common carrier pipelines, in some of which Clark has a minority interest. The Blue Island refinery can receive delivery of Canadian crude oil through the Lakehead Pipeline from Canada and foreign and domestic crude oil through the Capline Pipeline system originating in the Louisiana Gulf Coast and domestic crude oil originating in West Texas, Oklahoma and the Rocky Mountains through the Arco Pipeline system. The Hartford refinery has access to foreign and domestic crude oil supplies through the Capline/Capwood Pipeline systems along with access to West Texas, Oklahoma and Rocky Mountain crude oil from the Platte Pipeline system. The fact that both refineries are situated on major water transportation routes provides flexibility to receive crude oil or intermediate feedstocks by barge when economically feasible.\nClark has a sour crude oil supply contract with P.M.I. Comercio Internacional, S.A. de C.V., an affiliate of Petroleos Mexicanos, S.A. de C.V. (\"Pemex\"). This contract is cancelable with three months' notice by either party but it is intended to remain in place for the foreseeable future. The volume is currently 35,000 barrels per day of Maya crude oil, with price determination based on a market related formula applicable to all Pemex-US customers. Other term crude oil supply agreements primarily consist of Canadian crude oil delivered to Blue Island. Approximately 23,000 barrels per day are currently under contract with three Canadian suppliers, cancelable with two months' notice by either party with another 4,000 barrels per day under contract through December 1994 without provision for cancellation. The above- referenced contracts provide approximately 48% of Clark's crude oil requirements which offer some security with respect to supply along with the flexibility to take advantage of spot market opportunities.\nManagement has established product scheduling and supply priorities for gasoline and diesel fuel. These ensure that Clark's retail network needs are met first and then products are distributed to its wholesale operations based on the highest average market returns before being sold into the spot market.\nClark employs several strategies to minimize the adverse impact on profitability of the volatility in feedstock costs and refined product prices. One strategy involves the purchase and sale of futures and options contracts on the New York Mercantile Exchange to minimize, on a short-term basis, Clark's exposure to the risk of fluctuations in crude oil prices and refined product margins. The number of barrels of crude oil and refined products covered by such contracts varies from time to time. Such purchases and sales are closely managed, are balanced daily and are subject to internally established risk standards. The results of these hedging activities affect refining costs of sales or inventory costs.\nClark's dedicated retail network also reduces risk by providing market sales representing approximately 60% of the refineries' gasoline production. In addition, the retail network benefits from a reliable and cost effective source of supply.\nWholesale Marketing and Distribution\nRefined products are distributed primarily through Clark's terminals, company-owned and common carrier product pipelines and by leased barges over the Mississippi, Illinois and Ohio Rivers. Clark owns and operates 14 product terminals which are strategically located throughout its market area, most of which have product blending capabilities. Terminal blending involves the blending of natural gasoline and other blendstocks with finished gasoline which reduces product cost, lowers emission producing potential and improves product quality. While other refiners engage in terminal blending, Clark believes that its degree of blending and refinery/terminal integration provides Clark with a competitive advantage over other refiners that do not have comparable blending capabilities. In addition to cost efficiencies in supplying its retail network, the terminals provide Clark with an additional source of revenues through sales of gasoline, Number 2 diesel fuel and other refined products to wholesale customers.\nThese terminals allow efficient distribution of refinery production through readily accessible pipeline systems which connect the wholesale distribution network. In addition, the terminals provide flexibility to direct wholesale product sales to more profitable truck rack customers as an alternative to spot market sales as market conditions dictate. Clark plans to broaden its wholesale customer base which is expected to provide, on average, higher margins than spot markets. In anticipation of the October 1993 deadline for low sulfur on- road diesel fuel, Clark focused efforts on building market presence and customer relationships with off-road diesel fuel users.\nClark's terminals and respective capacities as of December 31, 1993, were as follows:\nClark enters into refined product exchange agreements with unaffiliated companies to broaden its geographical distribution capabilities. Products are also received on exchange through 37 exchange terminals and distribution points throughout the Midwest.\nClark's pipeline interests as of December 31, 1993, were as follows:\nThese pipelines are operated as common carriers pursuant to published pipeline tariffs, which also apply to use by Clark. Clark also owns a dedicated pipeline from the Blue Island refinery to the company-owned terminal in Hammond, Indiana. Clark Pipe Line Company, an affiliate of Clark, owns a 33.1% interest in the Capwood Pipeline and leases space of approximately 15,000 barrels per day on the ARCO Pipeline. Each of these pipelines transports crude oil to the Hartford refinery.\nCOMPETITIVE CONSIDERATIONS\nThe petroleum industry is highly competitive in all phases, from the production and procurement of crude oil to the refining, distribution and marketing of refined and intermediate products. Many of Clark's competitors are large, integrated oil companies which, because of their diverse operations, stronger capitalization and better brand name recognition, may be better able than Clark to withstand volatile industry conditions, shortages of crude oil or intense price competition.\nThe principal competitive factors affecting Clark's refining business are crude oil and other feedstock costs, refinery efficiency, refinery product mix and product distribution and marketing transportation costs. Certain of Clark's larger competitors have refineries which are larger and more efficient and as a result, have lower per barrel costs. Clark has no crude oil reserves and is not engaged in exploration. Clark obtains all of its crude oil requirements from unaffiliated sources. Clark believes that it will be able to obtain adequate crude oil and other feedstocks at generally competitive prices for the foreseeable future.\nThe principal competitive factors affecting Clark's retail marketing business are locations of stores, product price and quality, appearance and cleanliness of stores and brand identification. Competition from large, integrated oil and gas companies, as well as convenience stores which sell motor fuel, is expected to continue. Clark believes it competes in the retail sale of gasoline principally on the basis of price, location, store cleanliness and the Clark brand name recognition in the Midwest.\nREGULATORY MATTERS\nThe release or discharge of petroleum and hazardous materials is not an uncommon occurrence at refineries, terminals and stores and may give rise to liability under various federal, state and local regulations relating to soil and ground water contamination. Clark has identified a variety of potential environmental issues at its refineries, terminals and stores. In addition, each refinery has areas on-site which may contain hazardous waste or hazardous constituent contamination and which may have to be addressed in the future at substantial cost. Many of the terminals may also require remediation due to the age of the underground tanks and facilities and as a result of current or past activities at the terminal properties including several significant spills and past on-site waste disposal practices.\nFederal, state and local laws and regulations establishing various health and environmental quality standards and providing penalties for violations thereof affect nearly all of the operations of the Company. Included among such statutes are the Clean Air Act of 1955, as amended (\"CAA\"), the Resource Conservation and Recovery Act of 1977, as amended (\"RCRA\") and the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"). Also significantly affecting the Company are the rules and regulations of the Occupational Safety and Health Administration (\"OSHA\").\nThe CAA requires the Company to meet certain air emission standards and to obtain and comply with the terms of discharge permits. The RCRA empowers the EPA to regulate the treatment and disposal of industrial wastes and to regulate the use and operation of underground storage tanks. CERCLA requires notification to the National Response Center of releases of hazardous materials and provides a program to remediate hazardous releases at uncontrolled or abandoned hazardous waste sites. The Superfund Amendments and Reauthorization Act of 1986 (\"SARA\") is a five year extension of the CERCLA cleanup program. Title III of SARA, the Emergency Planning and Community Right to Know Act of 1986, relates to planning for hazardous material emergencies and provides for a community's right to know about the hazards of chemicals used or manufactured at industrial facilities. The OSHA rules and regulations call for the protection of workers and provide for a worker's right to know about the hazards of chemicals used or produced at the Company's facilities.\nRegulations issued by the EPA in 1988 with respect to underground storage tanks require the Company, over a period of up to ten years, to install, where not already in place, detection devices and corrosion protection on all underground tanks and piping at retail gasoline outlets. The regulations also require periodic tightness testing of underground tanks and piping. Commencing in 1998, operators will be required under these regulations to install continuous monitoring systems for underground tanks.\nIn March 1989, the EPA issued Phase I of regulations under authority of the CAA requiring a reduction for summer months in 1989 in the volatility of gasoline (\"RVP\") (the measure of the amount of light hydrocarbons contained in gasoline, such as normal butane, an octane booster). In June 1990, Phase II of these regulations was issued by the EPA which would require further reduction in RVP beginning in May 1992. The Clean Air Act Amendments also established nationwide RVP standards which will apply as of May 1992, but do not exceed the EPA's Phase II standards.\nThe Clean Air Act Amendments will impact the Company primarily in the following areas: (i) starting in 1995 a \"reformulated\" gasoline (which would include content standards for oxygen, benzenes and\naromatics) is mandated in the nine worst ozone polluting cities, including Chicago and Milwaukee in the Company's market area; (ii) Stage II hose and nozzle controls on gas pumps to capture fuel vapors in nonattainment areas, including 400 company stores; (iii) more stringent refinery permitting requirements; and (iv) stricter refinery waste disposal requirements as a broader group of wastes are classified as hazardous. In addition, EPA regulations required that after October 1, 1993 the sulfur contained in on-road diesel fuel produced in the US must be reduced.\nClark cannot predict what environmental legislation or regulations will be enacted in the future or how existing or future laws or regulations will be administered or interpreted with respect to products or activities to which they have not previously been applied. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of the regulatory agencies or stricter interpretation of existing laws which may develop in the future, could have an adverse effect on the financial position or operations of Clark and could require substantial additional expenditures by Clark for the installation and operation of pollution control systems and equipment. See \"Item 3.\n\n\n\nITEM 3. LEGAL PROCEEDINGS\nGenerators of hazardous substances found in off-site disposal locations at which environmental problems are alleged to exist, as well as the owners of those sites and certain other classes of persons, are subject to claims brought by state and federal agencies under CERCLA and analogous state laws, regardless of fault or the legality of original disposal. Under CERCLA, a potentially responsible party (\"PRP\") may be held jointly and severally liable for any such claims.\nOn or about December 7, 1988, \"Clark Oil\" was named as PRP by the EPA with respect to a solid waste disposal site in Gary, Indiana known as the 9th Avenue Site and was ordered to participate with approximately 250 other PRPs in the interim clean-up of that site. Information from the EPA and other parties involved indicated that Old Clark may have transported waste oils and solvents to the site during the mid 1970s. Pursuant to an Administrative Services Agreement then in effect between Clark and Old Clark, Clark responded to initial inquiries and advanced $160,000 for preliminary studies and clean-up of that site. Upon the expiration of the Administrative Services Agreement on November 30, 1990, Clark notified the EPA and other parties involved with respect to the site that Clark's involvement on behalf of Old Clark was terminated and advised that further contacts with respect to this site should be directed to Old Clark. Clark has received no information concerning the site since that notification. Clark believes it has no liability for this site because of the terms of the Asset Purchase Agreement with Old Clark, as approved by the Bankruptcy Court, which provided that Clark would not assume environmental liabilities arising prior to the date of closing. Based on information received by Clark during its involvement pursuant to the Administrative Services Agreement, the estimated total clean-up of this site ranged from $22 to $35 million. Clark has no information on the current amounts estimated for clean-up or amounts actually spent for clean-up.\nOn or about March 17, 1989, \"Clark Oil\" was named as PRP by the EPA with respect to a solid waste disposal site in Chicago, Illinois known as the U.S. Scrap Site and along with approximately 250 other PRPs was ordered to reimburse the EPA for $1.5 million in costs incurred in performing preliminary work on that\nsite. Information from the EPA and other parties indicated that Old Clark may have sent waste oils to the site during the 1970s. No information has been revealed which would indicate that Clark had any involvement with this site. Pursuant to the Administrative Services Agreement with Old Clark then in effect, Clark responded to initial inquiries about the site. However, Clark has advanced no payments related to the EPA's claim for reimbursement. Upon the expiration of the Administrative Services Agreement, on November 30, 1990, Clark notified the EPA that its involvement on behalf of Old Clark was terminated and advised that all future contacts with respect to the site should be directed to Old Clark. Clark has received no other information concerning the site since that notification. To the best of Clark's knowledge, the estimated amount being sought by the EPA was $1.5 million. Clark believes it has no liability for this site because of the terms of the Asset Purchase Agreement with Old Clark.\nOn September 15, 1989, \"Clark Oil & Refining Corp.\" received an inquiry from the EPA concerning any involvement at a disposal site in Texas City, Texas known as the Tex-Tin Site. On October 17, 1989, Clark responded that it had no connection to the site. Upon the expiration of the Administrative Services Agreement on November 30, 1990, Clark further notified the EPA that its involvement on behalf of Old Clark was terminated and advised that all future contacts with respect to the site should be directed to Old Clark. Clark has never received any information concerning potential costs involved in connection with this site, or any other parties which may be involved as potential PRPs. Clark presumes that all contamination would have been the result of activities of Old Clark and that Clark would have no liability because of terms of the Asset Purchase Agreement.\nAs indicated, Clark does not believe that it is a proper party to any of the above-described EPA claims. Clark cannot estimate costs for which it may ultimately be liable with respect to these three sites, but in the opinion of the management of Clark, these costs should not have a material adverse effect on Clark's operations or financial condition. There can be no assurance that Clark will not be named as a PRP at additional sites in the future or that the costs associated with those sites would not be substantial.\nIn late 1990, Clark received a letter from the Illinois Attorney General Environmental Control Division which included a report prepared by the Illinois Environmental Protection Agency (\"IEPA\") on its investigation of the Village of Hartford, Illinois ground water contamination. The report cited the history of the ground water contamination in the area including the installation by Old Clark in 1978 of recovery systems in Hartford for the removal of hydrocarbons from the surface of the ground water. The report identified Clark or Old Clark and two other oil companies as potential contributors to the contamination. In particular, it contended that Clark or Old Clark is the party primarily responsible for the hydrocarbon contamination and demanded that more aggressive and encompassing efforts be immediately initiated by Clark. Clark submitted its response to the letter and the report on January 15, 1991. In its response Clark indicated that, without admission of legal liability, it would continue to cooperate with the Illinois Attorney General and the IEPA by performing a remediation program meeting the objectives defined by the IEPA in its report. The response also contained data which disputed many of the contentions made by the IEPA. Clark's remediation plan was approved by the IEPA and the IEPA has issued all necessary permits to implement the remediation plan. The IEPA is provided with monthly progress reports. Clark successfully completed a major portion of the remediation work under an implementation plan that was submitted to the IEPA in August 1991. The necessity of future remediation work is being evaluated. Based upon the estimates of an independent environmental engineering firm, Clark established a $10 million provision for the estimated costs of its mitigation and recovery efforts of which $3.6 million has been spent to date.\nForty-one civil suits by residents of Hartford, Illinois have been filed against Clark in Madison County Illinois, alleging damage from ground water contamination. The relief sought in each of these cases is an unspecified dollar amount. The litigation proceedings are in the initial stages. Discovery, which could be lengthy and complex, is only just beginning. Clark moved to dismiss thirty-four cases filed in December 1991 on the ground that Clark is not liable for alleged activity of Old Clark. On September 4, 1992, the trial court granted Clark's motions to dismiss. The plaintiffs were given leave to re-file their complaints but based only on alleged activity of Clark occurring since November 8, 1988, the date on which the bankruptcy court with\njurisdiction over Old Clark's bankruptcy proceedings issued its \"free and clear\" order. In November 1992, the plaintiffs filed thirty-three amended complaints. In addition, one new complaint involving nine plaintiffs was filed. It is too early to predict whether any of these cases will go to trial on the merits and if so, what the risk of exposure to Clark would be at trial. It is also not possible to determine whether or to what extent Clark will have any liability to other individuals arising from the ground water contamination.\nIn November 1991, Clark learned that the EPA, the IEPA and the Cook County Department of Environmental Control were investigating the cause or causes of certain apparent exceedences of ambient air quality standards for sulfur dioxide in the vicinity of the Blue Island refinery. The EPA and the IEPA requested certain specific information from Clark, which Clark supplied. Clark has indicated that it will cooperate with the investigation of the apparent sulfur dioxide exceedences and has undertaken the requested monitoring and engineering procedures. Also in connection with the apparent exceedences, Clark received a Notice of Violation from the EPA in February 1992 and an Administrative Complaint and Notice of Proposed Order Assessing a Penalty of $50,000 in October 1992. Clark paid a penalty of $45,000 to the EPA in March 1994.\nClark received an Administrative Complaint from the EPA on June 12, 1992 alleging record keeping violations of the RCRA concerning 22 stores in Michigan, Indiana and Wisconsin and seeking civil penalties of $0.6 million. On March 18, 1993, Clark received an Amended Complaint from the EPA involving similar allegations but reducing the amount of civil penalties sought to $0.1 million. Clark received an Administrative Complaint from the EPA on January 5, 1993 alleging record keeping and related violations of the Clean Air Act concerning the Hartford refinery and seeking civil penalties of $0.1 million.\nOn May 5, 1993, Clark received correspondence from the Michigan Department of Natural Resources (\"MDNR\") indicating that the MDNR believes Clark may be a PRP in connection with ground water contamination in the vicinity of one of its retail stores in the Sashabaw Road area north of Woodhull Lake and Lake Oakland, Oakland County Michigan. Clark has begun an initial investigation into the matters raised by the MDNR. At the request of the MDNR, Clark has conducted an investigation into the historical use of its site, potential contaminants used at the site, third party sites which may be the source of contaminants and is also conducting a subsurface investigation of its site and the surrounding area. Clark has incurred approximately $25,000 in investigative activities to date. Clark does not know whether MDNR has identified other PRPs in connection with this matter, nor has it received any information from MDNR as to what it believes may be the ultimate cost associated with this site. Clark will not be able to prepare a corrective action plan and estimate potential clean-up costs until its investigatory work is complete.\nAn impoundment at the Hartford refinery contains hazardous wastes that were produced as the result of past operations. Clark has been evaluating remedial options with respect to that waste since 1992 and has been in discussions with the IEPA concerning those options. In April 1993 the IEPA told Clark that the presence of those hazardous wastes may require a permit under the RCRA and that in turn may require corrective action with respect to the entire refinery. Clark has received no formal notice or complaint with respect to these issues from the IEPA. Clark has begun an investigation with respect to the need for a permit and consequent corrective action. Based upon the estimates of an independent engineering firm, Clark established a $9.0 million provision for the estimated costs of site clean-up of which $7.2 million has been spent to date on remedial activities performed after notice to and comments from the IEPA.\nIn addition to the proceedings described above, Clark has various suits and claims against it. While it is impossible to estimate with certainty the ultimate legal and financial liability in respect to these other suits and claims, Clark believes the outcome of these other suits and claims will not be material in relation to its financial position.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInapplicable.\nPART II\nITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nInapplicable.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL DATA\n(IN THOUSANDS, EXCEPT RATIOS AND OPERATING DATA)\nThe following table sets forth, for the periods and dates indicated, selected financial and other data derived from the financial statements and related notes and the underlying books and records of Clark for the years ended December 31, 1993, 1992, 1991, 1990 and 1989. These selected financial and other data should be read in conjunction with the financial statements of Clark and related notes appearing elsewhere in this document.\n- -------- (a) Amortization includes amortization of turnaround costs and organizational costs. (b) Interest and financing costs, net, includes amortization of debt issuance costs of $1.2 million, $2.9 million, $6.0 million, $3.1 million and $9.1 million for the years ended December 31, 1993, 1992, 1991, 1990 and 1989 respectively. Interest and financing costs, net, also includes interest on all indebtedness, net of capitalized interest and interest income. (c) Other income in 1993 includes the final settlement of litigation with Drexel of $8.5 million and a gain from the sale of \"non-core\" stores of $2.9 million. Other income in 1992 includes the settlement of litigation with Apex and Drexel of $9.2 million and $5.5 million, respectively. Other expense in 1990 included a loss provision for $11.6 million representing the full amount of an overnight deposit held by Drexel. An additional 1990 loss provision of $10.0 million represents estimated costs of mitigation and recovery efforts resulting from alleged responsibility for ground water contamination in the town of Hartford, Illinois, adjacent to the Hartford refinery. A 1990 loss provision of $0.7 million reflected the inability of a former affiliate to repay its note due Clark. (d) Extraordinary item includes the recognition of deferred financing costs, premium amount and interest expense from September 30, 1992 through the redemption date of October 26, 1992, net of applicable income taxes on the redemption of the 12 1/4% First Mortgage Fixed Rate Notes due 1996. (e) On January 1, 1993, Clark adopted SFAS 106. This standard requires that Clark accrue the actuarially determined costs of postretirement benefits during the employees' active service periods. Previously, Clark had accounted for these benefits on a \"pay as you go\" basis, recognizing an expense when an obligation was paid. In accordance with SFAS 106, Clark elected to recognize the cumulative liability, a non-cash \"Transition Obligation\" of $9.6 million, net of the tax benefit of $6.0 million, as of January 1, 1993. On January 1, 1993, Clark adopted SFAS 109 and restated the years ended December 31, 1992 and 1991. The cumulative effect through December 31, 1990 is reflected as an adjustment to income in 1990 in this table. The adoption of this standard changes the method of accounting for income taxes from the deferred method to an asset and liability approach. Previously, Clark deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. (f) The ratio of earnings to fixed charges is computed by dividing (i) earnings before income taxes (adjusted to recognize only distributed earnings from less than 50% owned persons accounted for under the equity method) plus fixed charges by (ii) fixed charges. Fixed charges consist of interest on indebtedness, including amortization of discount and debt issuance costs and the estimated interest components (one-third) of rental and lease expense. (g) As a result of the losses for the years ended December 31, 1993 and 1992, earnings were insufficient to cover fixed charges by $17.3 million and $20.7 million respectively. (h) Retail operating expenses for 1992 exclude $5.8 million of charges that management considers to be unusual. (i) Refinery utilization is the ratio of total production yield to the rated capacity of the refinery to process crude oil. Production yield may be greater than the rated capacity of the refinery because other feedstocks (including partially refined products and liquefied petroleum gases), which add to the refinery's output are utilized in the refining process. (j) Refinery operating expenses for 1992 exclude $11.5 million ($0.22 per barrel) of charges that management considers to be unusual.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOverview\nClark's results are impacted significantly by a variety of factors beyond its control, including movements in crude oil prices, demand for refined products, general oil price levels and industry refinery capacity and utilization rates. Clark's net sales and operating revenues fluctuate significantly with movements in industry crude oil prices but they do not have a direct relationship to net earnings. The effect of changes in crude oil prices on Clark's operating results is determined more by the rate at which the prices of refined products adjust to reflect such changes. Management believes that lower crude oil prices benefit operating results over the longer term due to increased demand, decreased working capital requirements and a greater sensitivity by the major integrated oil companies to profitability in their refining and marketing operations. Higher refinery production is typically associated with improved results of operations. Conversely, lower production, which generally occurs during scheduled refinery maintenance turnarounds, negatively impacts results of operations.\nThe following table sets out the approximate pre-tax earnings impact on Clark of changes in: 1) refining margins--the spread between wholesale and spot market product prices and input (e.g. crude oil) costs and 2) retail margins-- the spread between product prices at the retail level and wholesale product costs. While margins are impacted significantly by the industry factors described above, individual companies can influence their own margins through the efficiency of their operations.\n*Changes in crude oil prices may affect the carrying value of inventories.\nFalling crude and product prices reduced 1993 and 1992 net sales and operating revenues, while improved unit volumes partially offset the drop. Crude and product prices have declined from the levels reached during the 1990 Iraqi invasion of Kuwait and the 1991 Soviet coup, which were viewed as potential threats to supply. Net sales and operating revenues were also affected by sales volumes; retail gasoline volumes were up 6% from 1992 and down 1% in 1992 as compared to 1991, and wholesale sales volumes were up 21% from 1992 and up 122% in 1992 as compared with 1991.\nCLARK FINANCIAL HIGHLIGHTS:\n*Management considers certain items in 1992 and 1993 at Clark to be \"unusual\". In 1993, the unusual items netted to a $30.7 million charge before taxes, $18.8 million net of taxes. In 1992, the unusual items netted to a $25.7 million charge before taxes, $13.4 million net of taxes. Detail on these items is presented below.\nNet earnings excluding unusual items improved in 1993 despite a decline in industry refining margins and reduced production associated with the scheduled maintenance turnaround at Clark's Blue Island, Illinois refinery. The gain was due to the combination of improved retail and refinery productivity and better retail market conditions. These improvements became significant in the latter part of 1993. Excluding unusual items, Clark's 1993 fourth quarter net earnings rose to $7.3 million compared to $0.4 million in 1992 and a loss of $2.5 million in 1991.\nUNUSUAL ITEMS\nSeveral items which are considered by management to be \"unusual\" are excluded throughout this discussion of Clark's results of operations. A non-cash accounting charge was taken in the fourth quarter of 1993 to reflect the decline in the value of petroleum inventories below carrying value caused by a substantial drop in prices. If petroleum prices were to recover, earnings would benefit up to the extent of this charge. Further deterioration in prices could result in further charges. Effective January 1, 1993, Clark adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (see Note 12 \"Postretirement Benefits Other Than Pensions\" to the financial statements) and No. 109 \"Accounting for Income Taxes\", which was accounted for by restating prior periods (see Note 13 \"Income Taxes\" to the financial statements). Unusual credits included a 1993 gain related to the sale of 21 retail stores located in \"non-core\" markets and the favorable settlement of litigation. See Note 11 \"Other Income\" to the financial statements. Unusual charges in 1992 included the early retirement of Clark's 12 1/4% First Mortgage Fixed Rate Notes due July 15, 1996, and provisions related to the environmental clean-up of the storm water basin at the Hartford, Illinois refinery and expected closures of under-performing retail stores. In addition, expenses related to early retirements and a severance program along with a canceled initial public offering were incurred in 1992.\nRetail\nRetail Division Operating Statistics:\n- -------- (1) Excludes unusual charges totaling $5.8 million, primarily related to restructuring and store closures.\nClark's retail division contributed $57.6 million in 1993 to operating income, up from $42.4 million excluding unusual items in 1992 and $55.9 million in 1991. The 1993 improvement is due to improved sales volumes and industry margins, while the decline in 1992 as compared to 1991 was due to decreased margins and the closure in late 1991 of stores representing approximately 2% of 1991 volume. Average monthly volumes per store in 1993 were up 9% over 1992 and 4% in 1992 over 1991 as a result of increased promotional activity, improved productivity and the closure of under-performing units. During selected periods of the year and in selected markets Clark ran promotions, including one that offered premium gasoline at the same price as regular unleaded gasoline. Margins per gallon improved in 1993 over the prior two years due to increased sales of higher margin premium gasoline, stronger retail market conditions and decreased competitive pricing pressures along with more responsive pricing strategies. Excluding unusual items, the retail division contributed $16.0 million to 1993 fourth quarter operating income compared to $14.6 million in the same periods of both 1992 and 1991.\nThe 1993 gross margin from convenience product sales rose 15% from 1992, with 1992 up 6% as compared to 1991. The average monthly contribution from convenience product sales per store for the 1993 was up 19% as compared to 1992 and 1992 was up 12% as compared to 1991. These improvements were principally due to improved vendor allowances, increased promotional activity, enhanced store merchandising and manager training, and store incentive plans.\nThe increase in 1993 operating expenses over 1992 and 1991 is related to costs incurred to implement a strategy to rework Clark's organizational structure to more fully involve the general work force in the operation of the business. These increased costs included higher labor, training, promotion and systems-related expenses. The increased promotional activity related to strengthening the Clark brand name, including purchasing of advertising and point of sale materials. Adding to the increase from 1991 to 1992 were expenses related to additional underground storage tank testing, a store associate bonus program and increased participation in the store health insurance program.\nRefining\nRefining Division Operating Statistics:\n- -------- (1) Excludes unusual charges totaling $11.5 million, primarily related to a provision for environmental remediation and restructuring.\nClark's refining division contributed $51.1 million to operating income in 1993, flat with the $51.2 million excluding unusual items contributed in 1992 and compared to $77.8 million in 1991. Industry refining margins continued the decline experienced in 1992, moving down further from the levels reached following the 1990 Persian Gulf conflict and the 1991 Soviet coup. This downward trend has occurred despite increasing demand for gasoline and distillate products. As reported by the American Petroleum Institute, US gasoline deliveries for 1993 rose by 1.5% versus a 1.1% increase in 1992, while distillates showed an increase of 2.1%. However, demand has been more than offset by high industry refinery runs, which have reached a crude oil throughput utilization rate of 91.5%, the highest level in at least 20 years. In addition, industry yield (as a percentage of crude oil runs) of light products grew, with gasoline and distillate output rising 2.7% and 5.0% respectively, further increasing the supply of these normally higher-margin products. This changing industry yield pattern has resulted from upgraded light-product processing, showing approximately a 10% increase in throughput over the past five years.\nClark's refining margins improved in 1993, especially in the third and fourth quarters and in relation to the decline in industry refining margin indicators. Excluding unusual items, the refining division contributed $20.8 million to 1993 fourth quarter operating income compared to $11.0 million in 1992 and a loss of $0.1 million in the same period of 1991. The third and fourth quarter refining division results improved on the strength of recent productivity initiatives, heavy oil and wholesale margins, and market profit opportunities presented by the mandated transition to low sulfur #2 oil for on-road use. This occurred despite third quarter losses related to a drop in crude and product prices, flooding in the midwestern US, and the significant drop in Midwest #2 oil prices. Refinery production for 1993 was down from 1992 due to the maintenance turnaround at the Blue Island refinery. Production during 1992 exceeded 1991 due to a turnaround at the Hartford refinery in 1991. Another turnaround is scheduled for the Hartford refinery in 1994.\nRefining operating expenses of $108.2 million in 1993 were just over 1992 operating expenses excluding unusual items of $106.5 million and 1991 expenses of $105.4 million. The uninsured portion of the cost associated with a gasoline spill from one of Clark's storage tanks in January 1994 is not expected to have a material effect on earnings.\nOutlook\nClark believes the demand for refined products will experience flat to only slight growth over the next several years, but expects that regulatory requirements and costs of entry will limit the industry's ability to meet demand. High current industry refinery utilization and the expected closure of marginal refineries due to increasing requirements for regulatory capital investments may result in a more positive long-term outlook for the refining and marketing industry.\nIn the near-term, Clark is looking to achieve significant productivity gains to secure its ongoing profitability. Clark has set a goal to achieve additional pre-tax productivity gains of $55 million in 1994, having achieved estimated gains of $20 million in 1993. These gains assume no improvement in industry margins, and in fact, Clark's earnings before depreciation, interest and taxes improved in the second half of 1993 despite deterioration in refining margins, as a result of the productivity gains achieved to date. In addition to this internal earnings growth, Clark is also pursuing growth in its retail and refining businesses through acquisitions.\nGeneral and Administrative Expense\nClark's general and administrative expenses were $27.5 million, higher than 1992 expenses of $24.8 million excluding unusual items and expenses of $20.8 million in 1991. Expenses in 1993 and 1992 were up principally due to higher labor and related costs, as Clark is making significant changes in its management, systems and procedures to benefit productivity in the longer term.\nDepreciation and Amortization\nDepreciation and amortization expenses have increased in the past three years due to the completion of higher cost refinery turnarounds in 1991 and 1993 and the recent higher levels of capital expenditures.\nNet Interest and Financing Costs\nClark's capital structure has changed significantly over the past three years, although the resulting effect on 1993 and 1992 net interest and financing costs has not been substantial. Clark's 1993 net interest and financing cost increase was principally due to lower interest income on less average funds invested and lower rates. See Note 8 \"Long-Term Debt\" to the financial statements.\nOther Income (Expenses)\nSee Note 11 \"Other Income\" to the financial statements for the items that comprise other income.\nLIQUIDITY AND CAPITAL RESOURCES\nFinancial Position\nCash generated by operating activities before working capital changes for the year ended December 31, 1993, was $62.2 million, $25.3 million greater than 1992 but $27.7 million under 1991. Cash flow has been impacted by the fluctuation in Clark's net earnings the past three years. Working capital at December 31, 1993, was $203.8 million, a 1.96 to 1 current ratio, versus working capital of $245.1 million, a 2.31 to 1 current ratio at December 31, 1992, and working capital of $304.1 million, a 2.82 to 1 current ratio, at December 31, 1991. The 1992 decline was principally a result of capital expenditures and the retirement of debt. See Note 8 \"Long-Term Debt\" to the financial statements.\nIn general, Clark's short-term working capital requirements fluctuate with the price of crude oil. Clark expects internally generated cash flows will be sufficient to meet its needs. Clark has in place a $100 million\ncommitted revolving line of credit expiring December 31, 1994, for cash borrowings and for the issuance of letters of credit primarily for purchases of crude oil, other feedstocks and refined products. At December 31, 1993, $51.5 million of the line of credit was utilized for letters of credit. There were no direct borrowings under Clark's line of credit at December 31, 1993 or 1992.\nCash flows from investing activities are primarily impacted by capital expenditures including maintenance turnarounds. During 1993, capital expenditures were $67.9 million compared with $59.5 million in 1992 and $58.0 million in 1991. Refinery division capital expenditures were $39.2 million in 1993 compared with $49.2 million in 1992 and $33.4 million in 1991. In addition, $20.6 million, $2.7 million and $17.2 million was spent for maintenance turnaround expenditures in 1993, 1992 and 1991 respectively. The increased spending in the refining division over the past three years has been primarily related to environmental projects. In 1993, projects included Stretford, crude and FCC unit upgrades at the Blue Island refinery while in 1992 projects included the distillate desulfurization project (subsequently delayed), vapor reduction and a new flare at the Hartford refinery. Retail expenditures were $26.5 million, $8.8 million and $23.6 million in 1993, 1992 and 1991 respectively. In 1993 nearly half of retail expenditures were environmental projects related to tanks, lines, vapor recovery and soil remediation. The balance of 1993 retail expenditures included discretionary projects such as store interior remodeling, systems automation and \"On The Go\" store concept development. Spending declined in 1992 and was limited primarily to environmental projects while a new long-term strategic plan was developed.\nClark projects 1994 capital expenditures to be approximately $80 million. Another $15 million is expected to be spent on a maintenance turnaround at the Hartford refinery. Estimated refining division capital expenditures of $40 million include $10 million for various environmental projects and $30 million of discretionary spending such as improvements to Hartford's crude and FCC units. Retail division capital expenditures are estimated to be $40 million including $20 million for environmental projects and $20 million for discretionary projects such as the addition of canopies and new dispensers to existing sites, the expansion of store interior selling space and \"reimaging\" locations under Clark's new logo and updated color scheme. Discretionary spending in each division will be linked to its operating cash flow.\nOver the period 1994 to 1998, Clark has preliminary plans to complete a number of environmental and other regulatory capital expenditure programs. These environmental expenditures comprise two major categories, those that are mandatory in order to comply with regulations pertaining to ground, water and air contamination, and those that are primarily discretionary involving the reformulation of refined fuel for sale into certain defined markets. The total mandatory expenditures for regulatory compliance over the next five years are estimated at approximately $100 million, split evenly between the retail and refining businesses. Costs of potential future regulations cannot be forecast.\nThe expenditures required to comply with reformulated fuels regulations are primarily discretionary, subject to market conditions and economic justification. The reformulated fuels programs impose restrictions on properties of fuels to be refined and marketed, including those pertaining to gasoline volatility, oxygenated fuel, detergent addition and sulfur content. The regulations regarding these fuel properties apply to different markets in which Clark operates, in certain circumstances at different times of the year.\nModifications estimated at $10-15 million to produce reformulated gasoline are being considered for the Blue Island refinery. The decision to proceed with such a project will depend on economic justification. A project initiated to produce low sulfur diesel fuel at the Hartford refinery was delayed in 1992 based on internal and third party analyses that indicated an oversupply of low sulfur diesel fuel capacity in Clark's marketplace. These analyses projected relatively narrow price differentials between low and high sulfur diesel products which have thus far been borne out after the initial transition to the low sulfur regulations. However, if price differentials widen sufficiently to justify investment, Clark could install the necessary equipment over a 14 to 16 month period at an estimated additional cost of $40 million. Furthermore, if Clark decided to install equipment necessary to produce reformulated gasoline and control sulfur emissions at Hartford, the gasoil desulfurizer and related equipment are estimated to cost an additional $90-130 million. These estimates have declined from a year ago as Clark has found more cost-effective methods of complying with regulations.\nClark's net cash flow used in financing activities was $1.1 million in 1993 and $38.7 million in 1992, while $119.1 million was provided in 1991. In 1991 and 1992, long-term debt was retired early and new debt was issued, principally to increase available cash and extend maturities of debt past the period when Clark expected to incur its largest capital expenditure requirements. See Note 8 \"Long-Term Debt\" to the financial statements. In 1993, Clark entered into several operating leases related to retail store automation equipment, coolers and beverage dispensers, office equipment, refinery lab equipment and a filter press.\nFunds generated from operating activities, together with Clark's existing cash, cash equivalents and marketable investments, are expected to be adequate to fund requirements for working capital and capital expenditure programs for the next year. Clark's future discretionary or environmentally-mandated spending, or acquisitions may require additional debt or equity capital.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this item is incorporated herein by reference to Part IV Item 14 (a) 1 and 2. Financial Statements and Financial Statement Schedules.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe directors and executive officers of Clark and their respective ages and positions are set forth in the table below.\nThe Board of Directors of Clark consists of three directors who serve until the next annual meeting of stockholders or until a successor is duly elected. Directors do not receive any compensation for their services as such. Officers of Clark serve at the discretion of the Board of Directors (and in the case of Messrs. Barnholt and Sigurdson, pursuant to employment agreements).\nPeter Munk has served as Chairman of the Board since July 1992, as Chairman of the Board and Chief Executive Officer from August 1990 through July 1992 and as Vice Chairman from November 1988 through August 1990. Mr. Munk has served as a director of the Company since November 1988. Mr. Munk has served as Chairman of the Board of Directors of Horsham since its formation in June 1987 and as Chairman and Chief Executive Officer and a director of Barrick since July 1984.\nPaul D. Melnuk has served as a director since October 1992, as President and Chief Executive Officer since July 1992, as President and Chief Operating Officer from February 1992 through July 1992, as Executive Vice President and Chief Operating Officer from December 1991 through February 1992, as Executive Vice President and Chief Financial Officer from November 1991 through December 1991, as Vice President and Chief Financial Officer from August 1990 through November 1991 and as Vice President from November 1988 through August 1990. Mr. Melnuk has served as President and Chief Operating Officer and as a director of Horsham since March 1992, as Executive Vice President and Chief Financial Officer of Horsham from May 1990 through February 1992 and as Vice President of Horsham from April 1988 through May 1990.\nC. William D. Birchall has been a director of Clark since November 1988. Mr. Birchall has been Chief Financial Officer of Arlington Investments Limited, a private investment holding company located in Nassau, Bahamas, for the last five years. Mr. Birchall has been a director of Barrick since July 1984 and a director of Horsham since 1987.\nBrandon K. Barnholt has served as Executive Vice President-Retail Marketing since December 1993 and Vice President-Retail Marketing from July 1992 through December 1993 and as Managing Director-Retail Marketing from May 1992 through July 1992. Mr. Barnholt previously served as Retail Marketing Manager of Conoco, Inc. from March 1991 through March 1992 and Lubricants Sales Manager from April 1988 through March 1991. During 1990 and 1989, Mr. Barnholt served as President of the Denver Conoco Credit Union.\nKevin P. Pennington has served as Executive Vice President-Corporate Services since December 1993 and as Vice President-Human Resources from July 1993 through December 1993. Previously Mr. Pennington served as Vice President-Human Resources for the Mercy Health System from April 1991 through July 1993 and as Assistant Vice President-Human Resources at GTE from June 1985 through April 1991.\nEric D. Sigurdson has served as Executive Vice President-Refining since December 1993, Vice President-Finance and Administration and Chief Financial Officer from October 1992 through December 1993 and as Vice President-Corporate Development from May 1992 to October 1992. Mr. Sigurdson has served as Vice President and Chief Financial Officer since November 1992 and as Vice President of Horsham since January 1992. From September 1989 through January 1992, Mr. Sigurdson served as President of Toronto Dominion Real Estate Inc. and as Director of Mergers & Acquisitions, Toronto Dominion Securities Inc. From April 1988 through September 1989, he served as corporate finance and real estate consultant at Cormax Capital Ltd.\nPatrick F. Heider has served as Secretary since October 1992. Mr. Heider has served as in-house counsel since April 1990. Mr. Heider previously was employed as an associate with the St. Louis law firm of Shepard, Sandberg & Phoenix from April 1988 through April 1990.\nThere are no arrangements or understandings between any director or executive officer and any other person pursuant to which such person was elected or appointed as a director or executive officer of Clark. There are no family relationships between any director or executive officer and any other director or executive officer.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the compensation paid to the most highly compensated executive officers of Clark earning in excess of $100,000.\n- -------- (a) Mr. Melnuk and Mr. Sigurdson receive compensation from Horsham for their services as President and Chief Operating Officer and Vice President and Chief Financial Officer, respectively, of Horsham. (b) Represents amounts accrued for the accounts of such individuals under the Clark Refining & Marketing, Inc. Savings Plan. (c) Payment of equity protection in sale of personal residence. (d) Number of shares covered by grants which may be exercised as stock options. These shares were granted under the Clark Refining & Marketing Stock Option Plan (the \"Option Plan\") and are exercisable for Subordinate Voting Shares of Horsham. Mr. Melnuk, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson hold options to acquire Subordinate Voting Shares of Horsham received as compensation from Horsham.\nCompensation of Clark's executive officers is determined by Clark's Board of Directors. Mr. Melnuk, Clark's President and Chief Executive Officer, is a member of Clark's Board of Directors.\nOPTION GRANTS IN 1993\nThere were no grants of stock options pursuant to Clark's Option Plan during the year ended December 31, 1993, to the executive officers named above. In 1993, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson received options to acquire Subordinate Voting Shares of Horsham from Horsham.\nYEAR-END OPTION VALUES\nThe following table sets forth information with respect to the number and value of unexercised options to purchase Subordinate Voting Shares of Horsham held by the executive officers named in the Summary Compensation Table at December 31, 1993. None of the named executive officers exercised any stock options during 1993.\n- -------- (a) Based upon the closing price on the New York Stock Exchange--Composite Transactions on December 31, 1993. (b) Mr. Melnuk, Mr. Barnholt, Mr. Pennington and Mr. Sigurdson hold options to acquire Subordinate Voting Shares of Horsham received as compensation from Horsham.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nCompensation of Clark's executive officers is determined by the Board of Directors. Mr. Melnuk, Clark's President and Chief Executive Officer, is a member of the Board of Directors. Other than reimbursement of their expenses, Clark's directors do not receive any compensation for their service as directors.\nEMPLOYMENT AGREEMENTS\nClark has an employment agreement with Mr. Sigurdson which provides for a term of three years commencing January 14, 1992 at a minimum annual salary of $150,000. In addition, Mr. Sigurdson was granted an option to purchase 100,000 shares of Subordinate Voting Shares of Horsham by Horsham which option shall become exercisable as to one-third of the shares on each of the first three anniversary dates of the granting of the option.\nClark has an employment agreement with Mr. Barnholt which provides for a term of three years commencing May 11, 1992 at a base annual salary of $112,500. In addition, Mr. Barnholt was granted an option to purchase 30,000 shares of Subordinate Voting Shares of Horsham, which option shall become exercisable as to one-third of the shares on each of the first three anniversary dates of the granting of the option.\nCLARK REFINING & MARKETING, INC. SAVINGS PLAN\nClark maintains the Clark Refining & Marketing, Inc. Savings Plan (the \"Plan\"), a profit sharing plan which permits employee before-tax contributions and provides for employer incentive matching contributions. The Plan was adopted effective January 1, 1989 and as of January 1, 1994 the assets under the related trust that implements and forms a part of the Plan are held in trust by Boatmen's Trust Company. Under the Plan, each employee of Clark and such other related companies as may adopt the Plan, who has attained age 21 (no age requirement effective April 1, 1994) and completed one year of service (six months of service effective April 1, 1994) may become a participant. Participants are permitted to make elective before-tax contributions to the Plan, effected through payroll reduction, from 2% to 12% (15% effective January 1, 1994) of their compensation. Clark makes matching contributions equal to 100% of a participant's elective before-tax contributions up to 6% of compensation (effective April 1, 1994 a 200% match of up to 3% of compensation). Participants are also permitted to make after-tax voluntary contributions through payroll deduction, from 2% to 5% of compensation, which are not matched by employer contributions. All employer contributions are vested at a rate of 20% per year of service, becoming fully vested after five years of service. Participants' vested accounts are distributable upon a participant's disability, death, retirement or separation from service. Subject to certain restrictions, employees may make loans or withdrawals of employee contributions during the term of their employment.\nCLARK REFINING & MARKETING, INC. STOCK OPTION PLAN\nIn 1991, Clark established a Stock Option Plan (the \"Option Plan\") under which options to purchase Subordinate Voting Shares of Horsham (\"Horsham Shares\") could be granted to certain of its non-employee directors and key employees. Under the Option Plan, options were granted for the purpose of attracting and motivating directors, officers and key employees. The Option Plan is administered by a committee of the Board of Directors consisting of two or more directors. Under the terms of the Option Plan, options granted to purchase Horsham Shares were at the market price of the Horsham Shares at the time of grant. In the event that an option holder ceases to be an employee, the holder (or the holder's estate) has three months to exercise the vested options. The maximum number of Horsham Shares authorized for issuance under the Option Plan, as amended, is 600,000.\nAs of December 31, 1993, there were 363,737 options outstanding to purchase shares of Horsham at prices ranging from $7.19 to $11.88 per share. The Company, under a trust agreement, held 253,738 Horsham shares at December 31, 1993 to meet obligations under the Option Plan.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll of Clark's common stock is owned by R & M Holdings, which is indirectly wholly owned by Horsham. R & M Holdings was formed by Horsham and AOC L.P. to acquire all of the capital stock of Clark and certain other assets. In connection with the Acquisition, AOC L.P., Horsham, R & M Holdings and Clark entered into a shareholder agreement, pursuant to which Horsham purchased 60% of the equity capital of R & M Holdings for $18 million and AOC L.P. purchased the remaining 40% of the equity capital of R & M Holdings for $12 million. AOC L.P. is a Missouri limited partnership, the sole general partner of which is G & N Investments, Inc.\nREPURCHASE OF STOCK\nOn December 30, 1992, R & M Holdings repurchased from AOC L.P. 34.67 shares of its common stock (approximately 87% of the shares of R & M Holdings common stock owned by AOC L.P.) and the option held by AOC L.P. to acquire common stock described above, for a purchase price of $90 million in cash and the transfer of all of the shares of CMAT, Inc. (\"CMAT\"), the principal asset of which is a Colorado ski resort. Horsham purchased the remaining 5.33 shares of common stock (approximately 13% of the shares of R & M Holdings common stock owned by AOC L.P.) for a purchase price of $10 million in cash and a warrant to purchase up to 3,000,000 subordinate voting shares of Horsham at an exercise price of $7.625 per share. In addition, a shareholder agreement was terminated. As of December 31, 1993, Peter Munk held approximately 80.9% voting control of Horsham.\nIn addition, R & M Holdings and Horsham have agreed to pay to AOC L.P. approximately 89% and 11%, respectively, of the Contingent Payment described below. The Contingent Payment is an amount, which shall not exceed in the aggregate $24 million plus interest at 9% per annum, compounded annually, calculated as a percentage of (i) the net cash flow of Clark for the years 1993, 1994, 1995 and 1996, in excess of specified levels and (ii) the net proceeds from sales, prior to January 1, 1997, of any equity security of R & M Holdings or Clark, or of certain assets of Clark or Clark Pipe Line Company or of certain mergers involving R & M Holdings or Clark, at prices in excess of specified levels. Any Contingent Payments due for 1993 were immaterial.\nThe shares of CMAT transferred to AOC L.P. were valued at approximately $9.9 million, following capitalization of certain intercompany debt held by Clark.\nIn connection with the foregoing transaction, AOC L.P., its principals and their affiliates, on the one hand and Horsham, R & M Holdings and Clark, on the other hand, delivered a Mutual Release of all claims, known or unknown, of either party against the other. In consideration of such release, Clark paid to AOC L.P. $2.5 million in cash.\nTo fund the repurchase of shares of its common stock, R & M Holdings borrowed $90 million pursuant to the Horsham Notes. The Horsham Notes consist of (i) a zero coupon note payable to Horsham issued on December 30, 1992 for a price of $75.0 million and maturing on June 28, 1993 in the face amount of approximately $79.6 million and (ii) a zero coupon note payable to a wholly owned subsidiary of Horsham issued on December 21, 1992 for a price of $15.0 million and maturing on June 19, 1993 in the face amount of approximately $15.9 million. The issue price of each of the Horsham Notes represented a yield to maturity of approximately 11.8%. The Horsham Notes were repaid on February 18, 1993 from the proceeds of a private debt placement by R & M Holdings.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nHorsham and Clark have agreements to provide certain management services to each other from time to time. During 1990, Clark arranged interim letter of credit facilities with two banks totaling $125.0 million requiring the guarantee of Horsham. Fees related to this interim financing arrangement and associated\nguarantee paid to Horsham in 1991 totaled $7.0 million. Clark has established trade credit with various suppliers of its petroleum requirements, occasionally requiring the guarantee of Horsham. Fees related to trade credit guarantees totaled $0.4 million during 1991 and $0.1 million in 1992.\nThe business relationships described above and any future business relationships with Horsham will be on terms no less favorable in any respect than those which could be obtained through dealings with third parties.\nRELATIONSHIP WITH R & M HOLDINGS\nFor Federal income tax purposes, Clark has been a member of the consolidated group of which R & M Holdings is the parent corporation (the \"R & M Holdings Group\").\nPursuant to a Tax Sharing Agreement in effect among R & M Holdings and each of its direct and indirect subsidiaries, for any year in which Clark is entitled to file a consolidated Federal income tax return with R & M Holdings, Clark generally is required to pay to R & M Holdings an amount equal to the amount of Federal income tax Clark would have paid had it computed its Federal income tax liability as a separate company in such year and any prior year. If Clark has or would have had an unused tax credit or loss which it could have carried back had it filed separate tax returns for all prior years, R & M Holdings must pay Clark an amount equal to the refund to which Clark would have been entitled. However, if Clark leaves the R & M Holdings Group, the Tax Sharing Agreement will cease to apply to it and it will no longer be entitled to reimbursement for the use of any of its losses, even if those losses result in refunds to the R & M Holdings Group or otherwise reduce the Federal income liability of the R & M Holdings Group, unless R & M Holdings otherwise agrees. Clark also may have to pay an additional amount to R & M Holdings or may be entitled to a payment from R & M Holdings if Clark's separately computed income, losses or credits are adjusted as a result of an audit by the Internal Revenue Service. The principles set forth above with respect to the Federal income taxes also apply to state taxes in those states where a combined income tax return can be filed.\nHolding's address is 8000 South Beech Daly Road, Taylor, Michigan 48180.\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(A) 1. AND 2. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe financial statements and schedules filed as a part of this Report on Form 10-K are listed in the accompanying index to financial statements and schedules.\n3. EXHIBITS\n(B) REPORTS ON FORM 8-K\nRegistrant filed a Form 8-K dated October 1, 1993 disclosing change of corporate name and trademark.\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Clark Refining & Marketing, Inc.:\nWe have audited the accompanying balance sheets of Clark Refining & Marketing, Inc. (formerly Clark Oil & Refining Corporation) (a Delaware corporation and wholly owned subsidiary of Clark R & M Holdings, Inc.) as of December 31, 1993 and 1992 and the related statements of earnings, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Clark Refining & Marketing, Inc. as of December 31, 1993 and 1992 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in notes 12 and 13 to the financial statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions and its method of accounting for income taxes.\nCoopers & Lybrand\nSt. Louis, Missouri, January 28, 1994\nCLARK REFINING & MARKETING, INC.\nBALANCE SHEETS\n(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nSTATEMENTS OF EARNINGS\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC. STATEMENTS OF CASH FLOWS\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nSTATEMENT OF STOCKHOLDER'S EQUITY\nDECEMBER 31, 1993\n(DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these statements.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1993, 1992, AND 1991\n(TABULAR DOLLAR AMOUNTS IN THOUSANDS OF US DOLLARS)\n1. GENERAL\nClark Refining & Marketing, Inc., formerly Clark Oil & Refining Corporation, a Delaware corporation (\"Clark\") was organized in 1988 for the purpose of acquiring the principal assets of OC Oil & Refining Corporation (formerly Clark Oil & Refining Corporation, a Wisconsin Corporation) (\"Old Clark\"), a wholly- owned subsidiary of Apex Oil Company, Inc. (formerly Apex Oil Company) (\"Apex\") and certain other assets of Apex. Clark is wholly-owned by Clark R & M Holdings, Inc., a Delaware corporation (\"R & M Holdings\"), and R & M Holdings is indirectly, wholly-owned by The Horsham Corporation, a Quebec corporation (\"Horsham\"). During December 1992, the 40% ownership interest of R & M Holdings that was held by AOC Limited Partnership, a Missouri limited partnership and affiliate of Apex (\"AOC, LP\"), was acquired by R & M Holdings and Horsham.\nClark's principal operations include crude oil refining, wholesale and retail marketing of refined petroleum products and the retail marketing of convenience store items in the Central United States.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash and Cash Equivalents; Short-term Investments\nClark considers all highly liquid investments, such as time deposits, money market instruments, commercial paper and United States and foreign government securities, purchased within three months of maturity, to be cash equivalents. Short-term investments consist of similar investments, as well as United States government security funds, maturing more than three months from date of purchase and are carried at the lower of cost or market. Clark invests only in AA rated or better fixed income marketable securities or the short-term rated equivalent.\nInventories\nInventories are stated at the lower of cost, predominantly using the last-in, first-out \"LIFO\" method, adjusted for realized hedging gains or losses on petroleum products, or market on an aggregate basis. To limit risk related to price fluctuations, Clark purchases and sells crude oil and refined products futures contracts as hedges of its production requirements and physical inventories. Gains and losses on futures contracts are recognized in earnings as a product cost component and as an adjustment to the carrying amount of petroleum inventories and are reflected when such inventories are consumed or sold.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is computed using the straight- line method over the estimated useful lives of the assets or group of assets. The cost of buildings and marketing facilities on leased land and leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life or the lease term. Clark capitalizes the interest cost associated with major construction projects based on the effective interest rate on aggregate borrowings.\nExpenditures for maintenance and repairs are expensed. Major replacements and additions are capitalized. Gains and losses on assets depreciated on an individual basis are included in current income. Upon disposal of assets depreciated on a group basis, unless unusual in nature or amount, residual cost less salvage is charged against accumulated depreciation.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Environmental Costs\nEnvironmental expenditures are expensed or capitalized depending upon their future economic benefit. Costs which improve a property as compared with the condition of the property when originally constructed or acquired and costs which prevent future environmental contamination are capitalized. Costs which return a property to its condition at the time of acquisition are expensed.\nDeferred Turnaround and Financing Costs\nA turnaround is a periodically required standard procedure for maintenance of a refinery that involves the shutdown and inspection of major processing units and occurs approximately every three years. Turnaround costs, which are included in \"Other assets\", are amortized over three years beginning the month following completion.\nFinancing costs related to obtaining or refinancing of debt are deferred and amortized over the expected life of the debt.\nIncome Taxes\nClark files a consolidated US federal income tax return with R & M Holdings but computes its provision on a separate company basis. On January 1, 1993, Clark adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") (see Note 13, \"Income Taxes\").\nDeferred taxes are classified as current and included in prepaid or accrued expenses or noncurrent depending on the classification of the assets and liabilities to which the temporary differences relate. Deferred taxes arising from temporary differences that are not related to a specific asset or liability are classified as current or noncurrent depending on the periods in which the temporary differences are expected to reverse.\nEmployee Benefit Plans\nThe Clark Refining & Marketing, Inc. Savings Plan and separate Trust (the \"Plan\"), a defined contribution plan covers substantially all employees of Clark. Under terms of the Plan, Clark matches the amount of employee contributions, subject to specified limits. Contributions to the Plan during 1993 were $2.7 million (1992--$2.7 million; 1991--$2.7 million).\nClark provides certain benefits for retirees once they have reached specified years of service. These benefits include health insurance in excess of social security and an employee paid deductible amount, and life insurance equal to one and one-half times the employee's annual salary. On January 1, 1993, Clark adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") which changed the method of accounting for such benefits from a cash to an accrual basis (see Note 12, \"Postretirement Benefits Other Than Pensions\").\n3. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of Clark's financial instruments as of December 31, 1993 was as follows:\nThe estimated fair value amounts were determined using quoted market prices for the same or similar issues.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe Financial Accounting Standards Board has issued SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". The standard generally replaces the historical cost accounting approach to debt securities with one based on fair value. All affected debt and equity securities must be classified as held-to-maturity, trading, or available-for-sale. Classification is critical as it effects the carrying amount of the security, as well as the timing of gain or loss recognition. Clark will adopt this standard beginning January 1, 1994 and expects most securities to be classified as available-for-sale with no material impact on the carrying values of the securities or earnings.\n4. INVENTORIES\nThe carrying value of inventories consisted of the following:\nInventories at December 31, 1993 were written down to market value which was $26.5 million lower than LIFO cost. The market value of inventories at December 31, 1992, was approximately $13.2 million higher than the carrying value.\n5. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consisted of the following:\nAt December 31, 1993, property, plant & equipment included $48.2 million (1992--$57.1 million) of construction in progress.\n6. OTHER ASSETS\nOther assets consisted of the following:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Amortization of deferred financing costs for the year ended December 31, 1993, was $1.2 million (1992--$2.9 million; 1991--$6.0 million). Amortization of turnaround costs during 1993 totaled $11.8 million (1992--$9.2 million; 1991--$7.0 million).\n7. WORKING CAPITAL FACILITY\nClark has in place a working capital facility which provides a revolving line of credit for cash borrowings and for the issuance of letters of credit primarily for securing purchases of crude oil, other feedstocks and refined products. The facility is for $100 million and expires December 31, 1994. There are restrictive limitations on inventory positions, and certain financial ratios are required to be maintained, including a net worth requirement of at least $130.0 million in 1993 and $140.0 million effective January 1, 1994. At December 31, 1993, $51.5 million (1992--$57.4 million) of the line of credit was utilized for letters of credit, of which $8.7 million (1992--$31.8 million) supports commitments for future deliveries of petroleum products. There were no direct borrowings outstanding under the facility at December 31, 1993 or 1992.\n8. LONG-TERM DEBT\nThe 9 1/2% and 10 1/2% Senior Notes were issued in September 1992 and December 1991, respectively and are both unsecured. The 9 1/2% Senior Notes and 10 1/2% Senior Notes are redeemable by Clark beginning September 1997 and December 1996, respectively at a redemption price which starts at 105% and decreases to 100% of principal two years later. The indentures for the Notes contain certain restrictive covenants including limitations on the payment of dividends, the payment of amounts to related parties, the level of debt, change in control and incurrence of liens. In addition, Clark must maintain a minimum net worth of $100 million.\nThe scheduled maturities of long-term debt during the next five years are (in thousands): 1994--$317 (included in \"Accrued expenses and other\"); 1995--$106; 1996--$99; 1997--$82; 1998--$121; 1999 and thereafter $400,630.\nInterest and financing costs\nInterest and financing costs, net consisted of the following:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) Cash paid for interest in 1993 was $40.1 million (1992--$52.1 million; 1991-- $35.1 million).\nInterest income in 1993 includes $0.2 million (1992--$2.0 million; 1991-- $(0.2) million) from CMAT (see Note 10 \"Related Party Transactions\").\nAccrued interest payable at December 31, 1993, of $6.9 million (1992--$6.7 million) is included in \"Accrued expenses and other\".\nEarly Extinguishment of Debt\nIn 1992 Clark repurchased $95.9 million of its First Mortgage Notes on the open market for $103.0 million and redeemed the remaining $104.1 million at 106% of principal amount, or $110.4 million. Available cash was used to extinguish the debt. The costs of the early extinguishment of debt of $11.5 million (net of taxes of $7.2 million) included the premium amount, deferred financing costs, and defeasance-related interest expense.\n9. LEASE COMMITMENTS\nClark leases premises and equipment under lease arrangements, many of which are non-cancelable. Clark leases store property and equipment with lease terms extending to 2013, some of which have escalation clauses based on a set amount or increases in the Consumer Price Index. Clark also has operating lease agreements for certain pieces of equipment at the refineries, retail stores, and the general office. These lease terms range from 3 to 9 years with the option to purchase the equipment at the end of the lease term at fair market value. The leases generally provide that Clark pay taxes, insurance, and maintenance expenses related to the leased assets. At December 31, 1993, future minimum lease payments under capital leases and non-cancelable operating leases were as follows (in millions): 1994--$4.9; 1995--$4.2; 1996--$4.0; 1997--$1.6; 1998--$1.6 and $4.6 thereafter. Rental expense during 1993 was $3.4 million (1992--$3.7 million; 1991--$3.4 million).\n10. RELATED PARTY TRANSACTIONS\nTransactions of significance with related parties not disclosed elsewhere in the footnotes are detailed below:\nApex Oil Company, Inc. and Subsidiaries\nClark had various agreements with Apex related to the sale of products (slurry oil, vacuum tower bottoms, asphalt) produced by the refineries. These agreements were terminated or expired in 1992 or 1991. The purchase and sale of products and services between the parties were made at market terms and prices. During 1992, Clark purchased $1.6 million (1991--$51.0 million) of its crude oil and other petroleum requirements from Apex and sold $0.7 million (1991-- $119.6 million) of refined product to Apex. There were no purchases from or sales to Apex in 1993.\nClark Executive Trust\nClark established a deferred compensation plan called the Clark Refining & Marketing, Inc. Corporation Stock Option Plan (the \"Stock Option Plan\") which became effective May 1, 1991. Under the Stock Option Plan, as amended, options to purchase up to 600,000 subordinate voting shares of Horsham could be granted to certain employees and non-employee directors. Exercise prices reflect the market value of Horsham stock on the date of issuance. As of December 31, 1993, there were 363,737 options outstanding to purchase shares of Horsham at prices ranging from $7.19 to $11.88 per share. The trust held 253,738 Horsham shares at December 31, 1993.\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nCMAT, Inc.\nOn December 30, 1992 the stock of CMAT Inc. (\"CMAT\") was transferred to an affiliate of Apex as part of the consideration for the acquisition by R & M Holdings for most of R & M Holdings' shares held by AOC, LP, an affiliate of Apex. As part of this transaction, Clark held a $10.0 million note due from CMAT December 31, 1997. This note was paid in full in early 1993.\n11. OTHER INCOME\nOther income consisted of the following:\nLitigation Settlements\nIn 1993 and 1992, Clark settled litigation and recovered all previous losses incurred relating to a line of credit with a lending syndicate (led by Drexel Trade Finance) that had filed bankruptcy in 1990. Also in 1992, Clark settled litigation against Apex related to a dispute arising out of the November 1988 acquisition of Clark's assets from Apex.\nRetail Stores\nIn June 1993, Clark sold 21 \"non-core\" retail stores in Kentucky and Minnesota, which resulted in the recognition of other income of $2.9 million.\n12. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nOn January 1, 1993, Clark adopted SFAS 106. This standard requires that Clark accrue the actuarially determined costs of postretirement benefits during the employees' active service periods. Previously, Clark had accounted for these benefits on a \"pay as you go\" basis, recognizing an expense when an obligation was paid. The cost of such benefits in 1992 and 1991 was not significant and these years have not been restated. In accordance with SFAS 106, Clark elected to recognize the cumulative liability, a non-cash \"Transition Obligation\" of $9.6 million, net of the tax benefit of $6.0 million, as of January 1, 1993. The current year effect of adopting SFAS 106 was $1.9 million ($1.2 million, net of taxes).\nThe following table sets forth the unfunded status for the post retirement health and life insurance plans as of December 31, 1993:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED) A discount rate of 7.25% was assumed as well as a 4.5% rate of increase in the compensation level. For measuring the expected postretirement benefit obligation, the health care cost trend rate ranged from 9.8% to 14.0% in 1993, grading down to an ultimate rate in 2001 of 5.25%. The effect of increasing the average health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation, as of December 31, 1993, by $2.2 million and increase the annual aggregate service and interest costs by $0.3 million.\n13. INCOME TAXES\nOn January 1, 1993, Clark adopted SFAS 109 retroactive to January 1, 1991. The adoption of this standard changes the method of accounting for income taxes from the deferred method to an asset and liability approach. Previously, Clark deferred the past tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities.\nThe 1992 and 1991 financial statements have been restated to give retroactive effect to the adoption of SFAS 109. As a result of the restatement, deferred income tax liabilities have increased and retained earnings has decreased at December 31, 1992 and 1991 by $8.4 million and $5.2 million, respectively. Before retroactive application of SFAS 109, the 1992 net loss was $5.1 million and the 1991 net income was $38.3 million. The respective effect of the retroactive application of SFAS 109 on these years' earnings was a $3.1 million and $1.0 million increase in the tax provision, resulting in a net loss for 1992 of $8.2 million and net earnings for 1993 of $37.3 million.\nThe income tax provision (benefit) including the impact of the accounting change in 1993 and the extraordinary item in 1992 is summarized as follows:\nA reconciliation between the income tax provision computed on pretax income at the statutory federal rate and the actual provision for income taxes is as follows:\nCLARK REFINING & MARKETING, INC.\nNOTES TO FINANCIAL STATEMENTS--(CONTINUED)\nThe following represents the approximate tax effect of each significant temporary difference giving rise to deferred tax liabilities and assets.\nAs of December 31, 1993, Clark has made payments of $14.3 million under the Federal alternative minimum tax system which are available to reduce future regular income tax payments. Net cash tax refunds of $6.6 million were received during 1993. Net cash paid for income taxes in 1992 was $2.2 million and $3.2 million in 1991.\nFederal income taxes payable at December 31, 1993, of $2.7 million (1992-- $5.9 million receivable) are due to R & M Holdings, an affiliate, in accordance with a tax-sharing agreement between Clark and R & M Holdings and are included in \"Accounts payable\".\n14. CONTINGENCIES\nForty-one civil suits by residents of Hartford, Illinois have been filed against Clark in Madison County Illinois, alleging damage from ground water contamination. The relief sought in each of these cases is an unspecified dollar amount. The litigation proceedings are in the initial stages. Discovery, which could be lengthy and complex, is only just beginning. Clark moved to dismiss thirty-four cases filed in December 1991 on the ground that Clark is not liable for alleged activity of Old Clark. On September 4, 1992, the trial court granted Clark's motions to dismiss. The plaintiffs were given leave to re-file their complaints but based only on alleged activity of Clark occurring since November 8, 1988, the date on which the bankruptcy court with jurisdiction over Old Clark's bankruptcy proceedings issued its \"free and clear\" order. In November 1992, the plaintiffs filed thirty-three amended complaints. In addition, one new complaint involving nine plaintiffs was filed. It is too early to predict whether any of these cases will go to trial on the merits and if so, what the risk of exposure to Clark would be at trial. It is also not possible to determine whether or to what extent Clark will have any liability to other individuals arising from the ground water contamination.\nClark is subject to various legal proceedings related to governmental regulations and other actions arising out of the normal course of business, including legal proceedings related to environmental matters. While it is not possible at this time to establish the ultimate amount of liability with respect to such contingent liabilities, Clark is of the opinion that the aggregate amount of any such liabilities, for which provision has not been made, will not have a material adverse effect on its financial position.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Clark Refining & Marketing, Inc.:\nOur report on the financial statements of Clark Refining & Marketing, Inc. (formerly Clark Oil & Refining Corporation) is included on page 30 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the financial statement schedules as of and for the years ended December 31, 1993, 1992 and 1991 listed in Part IV, Item 14(a)(2) of this Form 10-K.\nIn our opinion, these financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCoopers & Lybrand\nSt. Louis, Missouri, January 28, 1994\nCLARK REFINING & MARKETING, INC.\nSCHEDULE I--MARKETABLE SECURITIES--OTHER INVESTMENTS\n(DOLLARS IN THOUSANDS)\nCLARK REFINING & MARKETING, INC.\nSCHEDULE V--PROPERTY, PLANT & EQUIPMENT (A)\n(DOLLARS IN THOUSANDS)\n- -------- (a) Depreciation of property, plant and equipment is computed using the straight-line method based upon the following estimated useful lives:\n(b) 1993 deductions include assets which transferred among divisions within the Company.\nCLARK REFINING & MARKETING, INC.\nSCHEDULE VI--ACCUMULATED DEPRECIATION OF PROPERTY, PLANT & EQUIPMENT\n(DOLLARS IN THOUSANDS)\nCLARK REFINING & MARKETING, INC.\nSCHEDULE X--SUPPLEMENTARY EARNINGS STATEMENT INFORMATION\n(DOLLARS IN THOUSANDS)\nOther items were not in excess of one percent of total sales and revenues.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nClark Refining & Marketing, Inc.\n/s/ Paul D. Melnuk By: _________________________________ Paul D. Melnuk President and Chief Executive Officer\nMarch 25, 1994\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT IN THE CAPACITIES AND ON THE DATE INDICATED.\nMarch 25, 1994"},"word_count":{"kind":"number","value":17699,"string":"17,699"},"character_count":{"kind":"number","value":114628,"string":"114,628"}}},{"rowIdx":292,"cells":{"filename":{"kind":"string","value":"4829_1993.txt"},"id":{"kind":"string","value":"4829_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"4829"},"text":{"kind":"string","value":"Item 1. Business. GENERAL\nAmerican Cyanamid Company, a Maine corporation organized in 1907, is a research-based life sciences company which, together with its subsidiaries (collectively \"Cyanamid\"), discovers and develops medical and agricultural products, and manufactures and markets them throughout the world. Cyanamid operates 17 research laboratories, and its products are sold by its divisions and subsidiaries in more than 135 countries.\nIn December 1993, Cyanamid substantially completed the spin-off of Cytec Industries Inc. (\"Cytec\"), which encompassed substantially all of Cyanamid's chemicals businesses including plant food, and on January 24, 1994, Cytec common shares were distributed as a taxable dividend to shareholders. Cyanamid retained a $200 million preferred stock interest in Cytec. The chemicals businesses included: chemicals for water treating, paper, mining and oil field applications; building block chemicals, including acrylamide, acrylonitrile, melamine and sulfuric acid; amino resins, sold primarily to the coatings industry for use in paints; specialty materials, including adhesives and composites for the aerospace industry; specialty chemicals, including polymer additives, surfactants and phosphine chemicals; and acrylic fibers. Cytec assumed responsibility for substantially all liabilities (including environmental liabilities and liabilities for post- retirement benefits payable to employees of and retirees from Cyanamid's former chemicals business) and obligations associated with Cyanamid's former chemicals businesses (except for environmental liabilities at one former chemicals plant site - see Item 3), and agreed to indemnify Cyanamid against such liabilities and obligations. The Cytec preferred stock issued to Cyanamid contains various financial covenants designed to ensure that Cytec retains adequate financial strength to discharge the liabilities and obligations against which it is indemnifying Cyanamid. The remedies for breach of these financial covenants include Cyanamid's right of approval of Cytec's capital expenditure plans (thus exercising control over cash outlays) and, in certain cases, the ability by Cyanamid to nominate a majority of the Cytec Board of Directors. A two-member committee of the Cytec Board of Directors oversees environmental matters. Cyanamid's representative on the Cytec Board is one of the members of that committee.\nThe operating results of the chemicals businesses have been accounted for as discontinued operations. Accordingly, the 1993 consolidated financial statements exclude amounts for discontinued operations from items under captions applicable to continuing operations. The 1992 and 1991 consolidated financial statements and Form 10-K information and financial statement schedules have been restated to conform with the 1993 presentation.\n\"Operations By Business Groups and Geographic Areas\" on pages 49 through 51 of the American Cyanamid Company Annual Report to Shareholders for the year ended December 31, 1993 (\"Shareholders Report\") are incorporated by reference.\nBUSINESS GROUPS\nMedical. Medical products encompass LEDERLE branded and generic pharmaceutical products; over-the-counter products including CENTRUM and other multivitamins; LEDERLE-PRAXIS vaccines; DAVIS & GECK surgical sutures, wound management devices and instruments for minimally invasive surgery; STORZ ophthalmic, ear, nose and throat surgical devices, ophthalmic pharmaceuticals and intraocular lenses; and ACUFEX arthroscopic instruments and equipment.\nOn June 1, 1993, Cyanamid and Immunex Corporation, a biopharmaceutical company based in Seattle, Washington, created a new biopharmaceutical company by merging Cyanamid's North American Lederle oncology business with Immunex. Cyanamid also contributed $350 million in cash to the new company, which retained the Immunex name. Cyanamid received 53.5% of the common stock of the new company. See Note 3 to the Consolidated Financial Statements in the Shareholders Report. Immunex's products consist of LEUKINE granulocyte-macrophage colony stimulating factor and Lederle's oncology products: NOVANTRONE mitoxantrone, leucovorin calcium, thiotepa, methotrexate, AMICAR aminocaproic acid and LEVOPROME methotrimeprazine.\nSee Note 3 to the Consolidated Financial Statements in the Shareholders Report for a description of a global, companywide restructuring program, and the charges related thereto, primarily in the medical business, announced in the fourth quarter of 1993.\nAgricultural. The agricultural business encompasses herbicides, such as the imidazolinone herbicides marketed as SCEPTER, PURSUIT, PURSUIT Plus and SQUADRON for soybeans, PROWL (marketed as STOMP outside the United States) for soybeans, cotton, corn, cereals, tobacco and vegetables, ARSENAL for vegetation control, and ASSERT for wheat and barley; insecticides, such as COUNTER and THIMET; plant growth regulators, such as CYCOCEL; animal feed supplements and health products, such as AUREOMYCIN; and, outside of the United States, AVOTAN, CYDECTIN and CYGRO, and animal vaccines.\nIn the fourth quarter of 1993, Cyanamid acquired the crop protection businesses outside of North America of the Royal-Dutch Shell Companies. The acquisition included all of the Shell Companies' crop protection products, including insecticides, such as TORQUE, FASTAC, RIPCORD and CASCADE; fungicides, such as DELAN and ACROBAT; and animal health products. It also included a biosciences research center at Schwabenheim, Germany; a major formulations facility in Genay, France; and other formulations sites around the world.\nAlso in the fourth quarter of 1993, Cyanamid acquired Arthur Webster Pty. Ltd., a privately-held Australian veterinary biologicals company to complement its previous acquisitions of Langford Laboratories and Laboratories Sobrino, S.A. Webster manufactures vaccine products at its bacterial and viral vaccine manufacturing facilities in Sydney, Australia.\nIn recent years, operating earnings of the Agricultural Group have been concentrated in the first half of the year. The acquisitions in 1993 are not expected to result in any material change to this concentration. The sales of imidazolinone herbicide products in the aggregate accounted for approximately 16.1% of the sales of Cyanamid in 1993, and 12.9% in 1992 and 11.9% in 1991, restated to exclude sales of the chemicals business.\nINTERNATIONAL OPERATIONS AND EXPORT SALES\nCyanamid products are produced or marketed in approximately 135 countries. United States export sales were $185.4 million in 1993, $178.5 million in 1992, and $164.8 million in 1991.\nInternational operations (exclusive of United States export sales) accounted for approximately 39.8% in 1993, 41.7% in 1992 and 42.0% in 1991 of net sales to unaffiliated customers. Because Cyanamid experienced an operating loss of $51.6 million in 1993 due to one-time, pre-tax charges relating to the Immunex acquisition and the restructuring program (see Note 3 to the Consolidated Financial Statements in the Shareholders Report), the calculation of the percentage of operating earnings attributed to international operations ($206.5 million) was not meaningful. International operations accounted for approximately 50.7% and 51.5%, respectively, of operating earnings in 1992 and 1991.\nInternational operations are subject to various risks which are not present in domestic operations, including political instability, the possibility of expropriation, restrictions on royalties, dividends and currency remittances, instability of foreign currencies, requirements for governmental approvals for new ventures and local participation in operations such as local equity ownership and workers' councils, and difficulty in obtaining financing for export sales particularly into countries of the former Soviet Union and Eastern Europe.\nCyanamid is organizing two joint ventures with Chinese nationals for the manufacture of medical products (mainly vitamins) and animal feed supplements. Special risks in doing business with China arise from current debates under most favored nation trading status under U.S. Trade Laws.\nDISTRIBUTION\nBusiness Group Principal Direct Customers\nMedical Wholesale and retail drug, food, health and beauty aid and mass merchandiser outlets, managed health care companies, hospitals, physicians, governmental agencies and ambulatory surgery centers.\nAgricultural Manufacturers of finished products, whole- salers, retailers, farmers and governmental agencies.\nRESEARCH, PATENTS AND TRADEMARKS\nCyanamid maintains 17 research laboratories, located in the United States, the United Kingdom, Germany, France, Australia, Canada, Japan, Italy, Brazil, Spain and the Philippines. Costs for research and process development in 1993, 1992 and 1991 totaled approximately $595.6 million, $530.7 million and $456.2 million, respectively.\nCyanamid owns or is licensed under many patents and trademarks for a variety of products and processes. Cyanamid's important imidazolinone herbicide products (including SCEPTER and PURSUIT) are covered by composition of matter and process patents. Many of Cyanamid's important medical products (including ORIMUNE poliomyelitis vaccine) are not covered by composition of matter patents and hence are at greater risk from generic competition than those products which are so covered. Cyanamid believes that in the aggregate its rights under patents, trademarks, and licenses are significant to its operations, but that no single patent, trademark or license, or any group thereof, is individually material to Cyanamid, other than the patents covering the imidazolinone herbicides.\nEMPLOYEES\nAs of December 31, 1993, Cyanamid had approximately 26,550 employees worldwide, of whom approximately 27% are hourly paid.\nGOVERNMENT REGULATION\nRegulation of Products. In the United States, the manufacture and sale of medical products for human or animal use are regulated by the Food and Drug Administration (\"FDA\"). Cyanamid regularly has numerous applications for pharmaceutical products, medical devices, animal health products and animal feed supplements pending before the FDA. Most applications include results of stringent and costly testing procedures. As a result of the governmental investigations relating to CYGRO coccidiostat combinations (see Item 3) FDA review of Cyanamid's animal health products has been subject to the FDA's fraud policy, and the FDA has generally refused to review any of Cyanamid's animal health applications. With the Justice Department investigation now completed, Cyanamid anticipates being able to commence procedures with the FDA designed to remove Cyanamid from the fraud policy. Cyanamid's human pharmaceutical and vaccine businesses have not been affected by this matter. The FDA is continuing to consider possible restriction on the use of sulfamethazine additives (which are sold by Cyanamid in combination with penicillin and tetracycline additives) in animal feed.\nReimbursement of expenditures for drugs and medical devices in state and federally funded programs is regulated by state and federal authorities. The federal Vaccine For Children entitlement program signed into law in 1993 as part of the Omnibus Budget Reconciliation Act (\"OBRA\") is expected to have an adverse effect on the sales and earnings of the vaccines business beginning in the fourth quarter of 1994 because states will be able to purchase vaccines at federal vaccine prices. In addition, increases in the federal vaccine prices will be limited to increases in the Consumer Price Index. OBRA also included provisions which reduced the federal income tax benefits related to manufacturing activities in Puerto Rico. The reduction in these Puerto Rico tax benefits will have an unfavorable impact on Cyanamid's future results of operations.\nThe Clinton administration and certain members of Congress have introduced legislation including various forms of price regulation which may, if enacted into law, have a significant impact on the health care industry. In addition, proposals related to health care alliances, federally mandated spending restrictions, creation of a Medicare rebate program covering prescription drugs, and various tax-law changes, if enacted, may have significant impact on the industry. Cyanamid cannot predict what health care reform measures will be implemented or the impact of any such measures on Cyanamid's future results of operations and cost of doing business.\nIn the United States, the manufacture and sale of pesticides are regulated by the Environmental Protection Agency (\"EPA\"). Cyanamid regularly has numerous applications for pesticides pending before the EPA. Most applications include results of stringent and costly testing procedures. No new pesticide, and no existing pesticide for a new use, may be manufactured, processed or used without prior notice to the EPA.\nThe EPA advised Cyanamid that a Special Review under the Federal Fungicide, Insecticide and Rodenticide Act may be initiated for two products, COUNTER terbufos and THIMET phorate, primarily on the basis of suspected avian risk. A Special Review proceeding could ultimately result in the cancellation of EPA registrations for both products.\nOutside the United States, medical products for human or animal use and agricultural chemicals are regulated by various agencies, often by standards which differ from those in the United States. In addition, pharmaceutical prices are controlled in many countries, and many countries such as Italy and Germany are increasingly imposing reimbursement limitations.\nEnvironmental Matters. Federal, state and foreign regulations impose stringent requirements for the control and abatement of air and water pollutants and the manufacture, transportation, storage, labeling, handling and disposal of substances designated hazardous.\nCyanamid is and has been involved in legal and regulatory proceedings relating to the investigation and cleanup of sites (both its own and third party sites) where hazardous substances have been disposed. In connection with the spin-off of Cytec, Cytec has assumed the environmental liabilities relating to the chemicals businesses, except for the former chemical business site at Bound Brook. This assumption is not binding on third parties, and if Cytec were unable to satisfy these liabilities, they would, in the absence of other circumstances, be enforceable against Cyanamid.\nFor information about pending environmental litigation, see Item 3, \"Legal Proceedings\".\nCyanamid is also conducting, and may in the future be required to conduct, cleanups of its U.S. operating sites, pursuant to the terms of permits required for the sites and other statutes and regulations relating to hazardous substances. Cyanamid has environmental cleanups planned or in progress at several sites outside the United States including the Genay, France formulations facility purchased from Shell.\nCapital and operating expenditures for environmental protection in 1993 were approximately $7.5 million and $39.4 million, respectively. Capital expenditures for environmental control facilities in 1994 are estimated to be about $19.9 million. Estimates of capital expenditures for environmental control facilities for 1995 have not yet been completed.\nItem 2.\n\n\nItem 2. Properties.\nCyanamid operates approximately 58 manufacturing, research and distribution facilities throughout the world. Cyanamid adjusts as it deems prudent the productive capacity of its manufacturing facilities. Capital spending, exclusive of acquisitions, in 1993, 1992 and 1991 was approximately $305.5 million, $311.1 million, and $300.2 million, respectively. In 1994, all planned capital expenditures are intended either to provide necessary capacity, to improve the efficiency of production units, to modernize or replace older facilities or to install equipment for protection of the environment. Some of the important United States facilities (all of which are owned by Cyanamid, except as noted), and the business groups served by such facilities, are:\nBothell, Washington Medical (Immunex) Bound Brook, New Jersey Medical Carolina, Puerto Rico Medical Clearwater, Florida Medical Danbury, Connecticut Medical Hannibal, Missouri Agricultural Manati, Puerto Rico Medical, Agricultural Mansfield, Massachusetts (leased) Medical Pearl River, New York Medical, Agricultural Princeton, New Jersey Agricultural Sanford, North Carolina Medical Seattle, Washington Medical (Immunex) St. Louis, Missouri Medical Wayne, New Jersey Corporate Headquarters West Henrietta, New York Medical Willow Island, West Virginia Agricultural (leased)\nOutside the United States, Cyanamid's principal manufacturing facilities are located in Argentina, Australia, Brazil, Canada, France, Germany, Great Britain, Italy, Mexico, Republic of Korea, Spain, Taiwan and Venezuela.\nItem 3.\nItem 3. Legal Proceedings.\nDeductible amounts under Cyanamid's liability insurance coverage (particularly product and environmental liability) are such that Cyanamid must regard itself, for practical purposes, as self-insured with respect to most events. Cyanamid has a self-insurance program which provides reserves for costs based on past claims experience.\nCyanamid and its subsidiaries are parties to numerous suits and claims arising out of the conduct of business, many of which involve very large damage claims, including claims for punitive damages. Included among such suits, as of March 30, 1994, are 22 involving personal injury or death allegedly occurring in connection with administration of Cyanamid's DTP (diphtheria-tetanus-pertussis) and oral polio vaccines.\nIn 1990, Cyanamid's supplier of MAXZIDE triamterene/ hydrochlorothiazide filed suit against Cyanamid alleging breach of a 1984 exclusive licensing agreement and seeking damages and rights to the MAXZIDE trademarks and trade dress owned by Cyanamid. After a trial on the merits in Federal District Court, a jury rejected the supplier's claims. Plaintiff's time to appeal has not expired.\nIn 1991, a suit was filed against Cyanamid alleging patent infringement by Cyanamid in the sale of HibTITER Haemophilus b conjugate vaccine in the United States and seeking damages. After trial on the merits, a district court held that the HibTITER vaccine did not infringe the patent claims cited by the plaintiffs and that the cited claims were invalid. The Court of Appeals for the Federal Circuit on October 6, 1993, affirmed the District Court's holding that the cited patent claims were not infringed. Plaintiffs filed a Petition for a Writ of Certiorari in the Supreme Court of the United States on March 7, 1994, which is pending.\nEarly in 1994, Cyanamid pleaded guilty to a record keeping misdemeanor and paid a small fine related to allegations that a company employee had manipulated data related to CYGRO coccidiostat in combination with other products. The Cyanamid employee involved has been named in an Information by the government in the District of Maryland which charges a similar offense.\nThe Federal Trade Commission has subpoenaed information concerning (i) Cyanamid's opposition to a petition by another company to the FDA to reclassify sutures and a patent infringement lawsuit against that company, (ii) sales of childhood vaccines to governmental purchasers, and (iii) prices charged for certain agricultural products. Cyanamid has been informally advised by the Federal Trade Commission that it has closed its investigation relating to childhood vaccines.\nCyanamid has been named as one of many defendant pharmaceutical manufacturers and distributors in a number of federal and state civil antitrust suits alleging that the defendants conspired to discriminate against retail druggists by providing lower prices to mail order pharmacies, health maintenance organizations and similar purchasers.\nAs of December 31, 1993, Cyanamid was a party to, or otherwise involved in, legal proceedings directed at the cleanup of 39 Superfund sites, including the Bound Brook site. As of March 30, 1994, the number of Superfund sites is 40. These 40 sites include certain sites for which Cytec and Cyanamid have agreed to share responsibility. See Note 2 to the Consolidated Financial Statements in the Shareholders Report. In many cases, future environmental related expenditures cannot be quantified with a reasonable degree of accuracy. It is Cyanamid's policy to accrue environmental cleanup costs if it is probable that a liability has been incurred and an amount is reasonably estimable. As assessments and cleanups proceed, these liabilities are reviewed periodically and adjusted as additional information becomes available. Environmental liabilities are inherently unpredictable. The liabilities can change substantially due to such factors as additional information on the nature or extent of contamination, methods of remediation required, and other actions by governmental agencies or private parties. The aggregate environmental related accruals were $187.3 and $120.4 at December 31, 1993, and 1992, respectively. The increase in the accrual from 1992 to 1993 relates primarily to the Bound Brook facility and results from the determination of a method and a cost for remediating three lagoons at the Bound Brook site. The cost of cleanups for which Cyanamid remains primarily liable may be in excess of current environmental related accruals. All accruals have been recorded without giving effect to any possible future insurance proceeds. Insurance coverage of various environmental matters are currently being litigated but potential recoveries, if any, are unknown at this time. Cash expenditures often lag by a number of years the period in which an accrual is recorded.\nWhile it is not feasible to predict the outcome of all pending suits and claims, based on the most recent review by management of these matters, management is of the opinion that their ultimate disposition will not have a material adverse effect upon the consolidated financial position of Cyanamid.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted during the fourth quarter of Cyanamid's fiscal year 1993 to a vote of security holders.\nItem 10 (in part). Executive Officers of the Registrant.\nYear first elected Name Position to present office Age\nAlbert J. Costello Director (1990), Chairman 1993 58 of the Board (1993), Chief Executive Officer (1993) and Chairman of the Executive Committee\nFrank V. AtLee Director (1990), President 1993 53 (1993), Chairman of Cyanamid International, and Member of the Executive Committee\nDavid R. Bethune Group Vice President and 1992 53 Member of the Executive Committee\nDavid Lilley Group Vice President and 1992 47 Member of the Executive Committee\nWilliam J. Murray Group Vice President and 1992 49 Member of the Executive Committee\nLarry Ellberger Vice President 1992 46\nTerence D. Martin Vice President, 1991 50 Treasurer (1994), Chief Financial Officer (1991), Chairman of the Committee on Investment of Pension Funds and Member of the Executive Committee\nJoseph S. McAuliffe Vice President and 1993 54 General Counsel\nWilliam A. Stiller Vice President 1991 42\nPaul W. Wood Vice President, External 1990 49 Affairs\nAll of the executive officers of Cyanamid except Mr. Wood have held positions involving executive or management functions with Cyanamid for at least the past five years. Mr. Wood has been employed at Cyanamid since April 1990. Prior thereto, he had been Vice President, Investor Relations, of Squibb Corporation and previously Director, Investor Relations, of Upjohn Company.\nThe Executive Committee is not a committee of Cyanamid's Board of Directors.\nPART II\nItem 5.\nItem 5. Market for Registrant's Common Equity and Related Shareholder Matters.\n\"Financial Review-Common Stock and Dividends Paid\" in the Shareholders Report on page 33 is incorporated by reference.\nItem 6.\nItem 6. Selected Financial Data.\n\"Five-Year Summary\" in the Shareholders Report on page 53 is incorporated by reference.\nThe selected financial data should be read in conjunction with the consolidated financial statements. See Item 8.\nItem 7.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\n\"Discussion and Analysis of Financial Condition and Results of Operations\" in the Shareholders Report on pages 54 through 58 is incorporated by reference.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements on pages 35 through 51, together with the report thereon of KPMG Peat Marwick dated February 8, 1994, on page 52, and \"Financial Review-Quarterly Results\" on page 34, of the Shareholders Report, are incorporated by reference.\nItem 9.\nItem 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.\nNone.\nPART III\nItem 10\n\n\nItem 10 (in part). Directors and Executive Officers of the Registrant.\nThe information set forth on pages 2 through 6 (exclusive of descriptions of committees of the Board of Directors) under \"Election of Directors\" in the Proxy Statement for the Annual Meeting of Shareholders, dated March 8, 1994, (the \"Proxy Statement\") is incorporated by reference. The information incorporated by reference hereby is also responsive to the information required by Item 12. See also Item 10 (in part) in Part I of this Report.\nItem 11.\nItem 11. Executive Compensation.\nThe information on pages 14 through 29 of the Proxy Statement, under \"Executive Compensation\" and \"Directors' Compensation\", is incorporated by reference.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nSee Item 10.\nItem 13.\nItem 13. Certain Relationships and Related Transactions.\nNone.\nPART IV\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) 1. Financial statements (Incorporated by reference. See Item 8.)\nIndependent Auditors' Report Consolidated Statements of Operations Consolidated Statements of Earnings Employed in the Business Consolidated Balance Sheets Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\n2. Financial statement schedules.\nIndependent Auditors' Report\nFinancial Statement Schedules for each of the years in the three-year period ended December 31, 1993:\nV - Plants, equipment and facilities VI - Accumulated depreciation of plants, equipment and facilities VIII - Valuation and qualifying accounts IX - Short-term borrowings\nAll other schedules have been omitted because they are not applicable or the information required is shown in the consolidated financial statements or notes thereto.\n3. Exhibits.\n(3) A - Restated Articles of Incorporation of Registrant as amended through April 20, 1987 are incorporated by reference to Exhibit (3) A of Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\nB - By-Laws of Registrant as amended through March 10, 1987 are incorporated by reference to Exhibit (3)D of Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(4) A - Form of Rights Agreement, dated as of March 10, 1986, between American Cyanamid Company and The Chase Manhattan Bank, N.A., which includes as Exhibit A thereto the Form of Certificate of Designation, Rights and Preferences of Series A Junior Participating Preferred Stock of Registrant, and as Exhibit B thereto the Form of Rights Certificate, is incorporated by reference to Exhibit 1 to the Preferred Stock Purchase Rights Registration Statement on Form 8-A filed by Registrant on March 18, 1986.\nB - Amendment No. 1, dated April 30, 1986 to Rights Agreement is incorporated by reference to Form 8 filed by Registrant on May 1, 1986.\nC - Amendment No. 2, dated May 18, 1987 to Rights Agreement is incorporated by reference to Form 8 filed by Registrant on May 19, 1987.\nD - Letter Agreement, dated March 2, 1992, appointing Mellon Bank, N.A. as successor Rights Agent under the Rights Agreement is incorporated by reference to Exhibit (4)B of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\nE - See Exhibits (3)A, (3)B, (4)A, (4)B, (4)C and (4)D for rights of holders of Common Stock.\nF - No instrument defining the rights of the holders of any long-term debt of Registrant or any subsidiary authorizes issuance of debt securities of 10% or more of the total assets of the Registrant and its subsidiaries on a consolidated basis. Accordingly, Registrant agrees, in lieu of filing any such instruments, to provide copies thereof to the Securities and Exchange Commission upon its request, as contemplated by paragraph (b) (4) (iii) of Item 601 of Regulation S-K.\n(10) A - Executive Compensation Plans and Arrangements\n1 1977 Employees Stock Plan of Registrant, as amended through August 20, 1985, is incorporated by reference to Exhibit (10)B of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n2 Amendments to the 1977 Employees Stock Plan of Registrant, adopted as of April 21, 1987 and April 19, 1988, are incorporated by reference to Exhibit (10)C of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n3 Amendment to the 1977 Employees Stock Plan of Registrant, adopted as of April 17, 1989, is incorporated by reference to Exhibit (10)C of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n4 Amendment to the 1977 Employees Stock Plan of Registrant, adopted as of April 20, 1992 is incorporated by reference to Exhibit (10)B of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n5 1984 Employees Stock Plan of Registrant, as amended through April 17, 1990, is incorporated by reference to Exhibit (10)D of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n6 Amendment to the 1984 Employees Stock Plan of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)C of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n7 1992 Employees Stock Plan of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)A of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n8 Incentive Compensation Plan of Registrant, as amended through December 21, 1993.\n9 Form of Agreement under the Incentive Compensation Plan of Registrant, adopted as of August 20, 1985, is incorporated by reference to Exhibit (10)G of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n10 Form of Amendment to Agreement under the Incentive Compensation Plan of Registrant, adopted as of April 19, 1988, is incorporated by reference to Exhibit (10)H of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n11 Executive Income Continuity Plan of Registrant, as amended through August 16, 1993.\n12 Amendment to the 1977 Employees Stock Plan, the 1984 Employees Stock Plan, the Executive Income Continuity Plan, the Supplemental Employees Retirement Plan and the Agreements under the Incentive Compensation Plan (Exhibits (10)F and (10)G hereto) of Registrant, adopted as of December 20, 1988, is incorporated by reference to Exhibit (10)J of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n13 Supplemental Employees Retirement Plan of Registrant, as amended through February 21, 1989, is incorporated by reference to Exhibit (10)K of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n14 Supplemental Employees Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)K of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n15 ERISA Excess Retirement Plan of Registrant, adopted as of February 21, 1989, is incorporated by reference to Exhibit (10)N of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n16 ERISA Excess Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)M of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n17 Compensation Taxation Equalization Plan of Registrant, adopted as of February 21, 1989, is incorporated by reference to Exhibit (10)P of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n18 Restricted and Deferred Stock Plan for Non-Employee Directors of Registrant, adopted as of April 18, 1988, is incorporated by reference to Exhibit (10)Q of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n19 Amendment to the Restricted and Deferred Stock Plan for Non-Employee Directors of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)E of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n20 Key Management Group Personal Excess Liability Insurance Policy made available by the Registrant to key management personnel, is incorporated by reference to Exhibit (10)R of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n21 Form of agreement for deferral of directors' compensation is incorporated by reference to Exhibit (10)E to Registrant's Annual Report on Form 10-K for the year ended December 31, 1980.\n22 Form of minimum pension guarantee given to certain executive officers is incorporated by reference to Exhibit (10)M of Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n23 Non-Employee Directors Retirement Plan, adopted as of April 18, 1989 and amended as of January 1, 1991, is incorporated by reference to Exhibit (10)S of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n24 Non-Employee Directors Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)T of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n25 Supplemental Retirement Plan for Existing Retirees, adopted as of August 16, 1988, is incorporated by reference to Exhibit (10)U of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n26 Form of Trust Agreement to the Supplemental Retirement Plan for Existing Retirees, adopted as of August 16, 1988, is incorporated by reference to Exhibit (10)V of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n27 Employment Agreement of T. D. Martin, signed October 17, 1988.\n(13) Annual Report to Shareholders for the year ended December 31, 1993. Except for those portions thereof which are expressly incorporated by reference in this Annual Report on Form 10-K, such Annual Report to Shareholders is furnished for the information of the Commission and is not deemed \"filed\" as part of this Annual Report on Form 10-K.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick.\n(24) A-K Powers of Attorney of F. V. AtLee, D. M. Culver, A. R. Dragone, R. Halstead, A. J. Levine, P. W. MacAvoy, V. T. Marchesi, T. D. Martin, G. J. Sella, Jr., M. Tanenbaum and A. Wexler.\n(b)\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nUndertaking\nFor the purposes of complying with the amendments to the rules governing Form S-8 (effective July 13, 1990) under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on Form S-8 Nos. 2-61193, 2-76933, 2-95992, 33-34218, 33-50242 and 33-60140.\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.\nSIGNATURES\nPursuant to the requirement of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAMERICAN CYANAMID COMPANY (Registrant)\nDATE: March 30, 1994 By A. J. Costello A. J. Costello Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.\nDATE: March 30, 1994 A. J. Costello A. J. Costello Chairman and Chief Executive Officer (Principal Executive Officer and Director)\nF. V. AtLee, Director\nD. M. Culver, Director\nA. R. Dragone, Director\nDATE: March 30, 1994 R. Halstead, Director By R. T. Ritter (Attorney-in A. J. Levine, Director Fact)\nP. W. MacAvoy, Director\nV. T. Marchesi, Director\nT. D. Martin, Vice President (Principal Financial Officer)\nR. T. Ritter, Controller (Principal Accounting Officer)\nG. J. Sella, Jr., Director\nM. Tanenbaum, Director\nA. Wexler, Director\nItem 14 (a) 2\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders American Cyanamid Company:\nUnder date of February 8, 1994, we reported on the consolidated balance sheets of American Cyanamid Company and subsidiaries as of December 31, 1993 and 1992 and the related consolidated statements of operations, earnings employed in the business, and cash flows for each of the years in the three-year period ended December 31, 1993, as contained in the 1993 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1993. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedules as listed in Item 14(a)2 of the accompanying Form 10- K. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.\nIn our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 1 to the consolidated financial statements, the company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", and No. 109, \"Accounting for Income Taxes\", effective January 1, 1993.\nKPMG Peat Marwick\nKPMG Peat Marwick Short Hills, New Jersey February 8, 1994\nItem 14 (a) 2\nPAGE\nItem 14 (a) 2\nItem 14 (a) 2\nPAGE\nUNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K\n(Mark One) / x / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]\nFor the fiscal year ended December 31, 1993 OR / /TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]\nFor the Transition period from to Commission file number 1-3426\nAMERICAN CYANAMID COMPANY\n(Exact name of registrant as specified in its charter)\nMaine 13-0430890 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)\nOne Cyanamid Plaza Wayne, New Jersey (Address of principal executive offices) 07470 (Zip Code)\nRegistrant's telephone number, including area code (201) 831-2000\nSecurities registered pursuant to Section 12(b) of the Act:\nName of each exchange on Title of each class which registered Common Stock, par value $5 per share New York Stock Exchange\n7 3/8% Sinking Fund Debentures Due 2001 New York Stock Exchange\n8 3/8% Sinking Fund Debentures Due 2006 New York Stock Exchange\nSecurities registered pursuant to Section 12(g) of the Act:\nNone (Title of Class) EXHIBITS INDEX TO EXHIBITS\n(3) A - Restated Articles of Incorporation of Registrant as amended through April 20, 1987 are incorporated by reference to Exhibit (3) A of Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\nB - By-Laws of Registrant as amended through March 10, 1987 are incorporated by reference to Exhibit (3)D of Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(4) A - Form of Rights Agreement, dated as of March 10, 1986, between American Cyanamid Company and The Chase Manhattan Bank, N.A., which includes as Exhibit A thereto the Form of Certificate of Designation, Rights and Preferences of Series A Junior Participating Preferred Stock of Registrant, and as Exhibit B thereto the Form of Rights Certificate, is incorporated by reference to Exhibit 1 to the Preferred Stock Purchase Rights Registration Statement on Form 8-A filed by Registrant on March 18, 1986.\nB - Amendment No. 1, dated April 30, 1986 to Rights Agreement is incorporated by reference to Form 8 filed by Registrant on May 1, 1986.\nC - Amendment No. 2, dated May 18, 1987 to Rights Agreement is incorporated by reference to Form 8 filed by Registrant on May 19, 1987.\nD - Letter Agreement, dated March 2, 1992, appointing Mellon Bank, N.A. as successor Rights Agent under the Rights Agreement is incorporated by reference to Exhibit (4)B of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\nE - See Exhibits (3)A, (3)B, (4)A, (4)B, (4)C and (4)D for rights of holders of Common Stock.\nF - No instrument defining the rights of the holders of any long-term debt of Registrant or any subsidiary authorizes issuance of debt securities of 10% or more of the total assets of the Registrant and its subsidiaries on a consolidated basis. Accordingly, Registrant agrees, in lieu of filing any such instruments, to provide copies thereof to the Securities and Exchange Commission upon its request, as contemplated by paragraph (b) (4) (iii) of Item 601 of Regulation S-K.\n(10) A - Executive Compensation Plans and Arrangements\n1 1977 Employees Stock Plan of Registrant, as amended through August 20, 1985, is incorporated by reference to Exhibit (10)B of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n2 Amendments to the 1977 Employees Stock Plan of Registrant, adopted as of April 21, 1987 and April 19, 1988, are incorporated by reference to Exhibit (10)C of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n3 Amendment to the 1977 Employees Stock Plan of Registrant, adopted as of April 17, 1989, is incorporated by reference to Exhibit (10)C of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n4 Amendment to the 1977 Employees Stock Plan of Registrant, adopted as of April 20, 1992 is incorporated by reference to Exhibit (10)B of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n5 1984 Employees Stock Plan of Registrant, as amended through April 17, 1990, is incorporated by reference to Exhibit (10)D of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n6 Amendment to the 1984 Employees Stock Plan of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)C of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n7 1992 Employees Stock Plan of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)A of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n8 Incentive Compensation Plan of Registrant, as amended through December 21, 1993.\n9 Form of Agreement under the Incentive Compensation Plan of Registrant, adopted as of August 20, 1985, is incorporated by reference to Exhibit (10)G of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n10 Form of Amendment to Agreement under the Incentive Compensation Plan of Registrant, adopted as of April 19, 1988, is incorporated by reference to Exhibit (10)H of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n11 Executive Income Continuity Plan of Registrant, as amended through August 16, 1993.\n12 Amendment to the 1977 Employees Stock Plan, the 1984 Employees Stock Plan, the Executive Income Continuity Plan, the Supplemental Employees Retirement Plan and the Agreements under the Incentive Compensation Plan (Exhibits (10)F and (10)G hereto) of Registrant, adopted as of December 20, 1988, is incorporated by reference to Exhibit (10)J of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n13 Supplemental Employees Retirement Plan of Registrant, as amended through February 21, 1989, is incorporated by reference to Exhibit (10)K of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n14 Supplemental Employees Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)K of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n15 ERISA Excess Retirement Plan of Registrant, adopted as of February 21, 1989, is incorporated by reference to Exhibit (10)N of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n16 ERISA Excess Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)M of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n17 Compensation Taxation Equalization Plan of Registrant, adopted as of February 21, 1989, is incorporated by reference to Exhibit (10)P of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n18 Restricted and Deferred Stock Plan for Non-Employee Directors of Registrant, adopted as of April 18, 1988, is incorporated by reference to Exhibit (10)Q of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n19 Amendment to the Restricted and Deferred Stock Plan for Non-Employee Directors of Registrant, adopted as of April 20, 1992, is incorporated by reference to Exhibit (10)E of Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992.\n20 Key Management Group Personal Excess Liability Insurance Policy made available by the Registrant to key management personnel, is incorporated by reference to Exhibit (10)R of Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n21 Form of agreement for deferral of directors' compensation is incorporated by reference to Exhibit (10)E to Registrant's Annual Report on Form 10-K for the year ended December 31, 1980.\n22 Form of minimum pension guarantee given to certain executive officers is incorporated by reference to Exhibit (10)M of Registrant's Annual Report on Form 10-K for the year ended December 31, 1985.\n23 Non-Employee Directors Retirement Plan, adopted as of April 18, 1989 and amended as of January 1, 1991, is incorporated by reference to Exhibit (10)S of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n24 Non-Employee Directors Retirement Plan Trust Agreement, between the Registrant and Morgan Guaranty Trust Company of New York, dated September 19, 1989, is incorporated by reference to Exhibit (10)T of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n25 Supplemental Retirement Plan for Existing Retirees, adopted as of August 16, 1988, is incorporated by reference to Exhibit (10)U of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n26 Form of Trust Agreement to the Supplemental Retirement Plan for Existing Retirees, adopted as of August 16, 1988, is incorporated by reference to Exhibit (10)V of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n27 Employment Agreement of T. D. Martin, signed October 17, 1988.\n(13) Annual Report to Shareholders for the year ended December 31, 1993. Except for those portions thereof which are expressly incorporated by reference in this Annual Report on Form 10-K, such Annual Report to Shareholders is furnished for the information of the Commission and is not deemed \"filed\" as part of this Annual Report on Form 10-K.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick.\n(24) A-K Powers of Attorney of F. V. AtLee, D. M. Culver, A. R. Dragone, R. Halstead, A. J. Levine, P. W. MacAvoy, V. T. Marchesi, T. D. Martin, G. J. Sella, Jr., M. Tanenbaum and A. Wexler."},"word_count":{"kind":"number","value":7542,"string":"7,542"},"character_count":{"kind":"number","value":49565,"string":"49,565"}}},{"rowIdx":293,"cells":{"filename":{"kind":"string","value":"720695_1993.txt"},"id":{"kind":"string","value":"720695_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"720695"},"text":{"kind":"string","value":"ITEM 1. BUSINESS\nGENERAL\nPathe Communications Corporation (the \"Company\") is a Delaware corporation with no operating assets or sources of operating income and total liabilities exceeding $269,000,000. The Company is wholly dependent upon Credit Lyonnais Bank Nederland N.V., a Dutch banking institution (\"CLBN\"), for all capital needed to fund its on-going cash requirements. As used herein, the terms \"Registrant\" and \"Pathe\" refer to the Company unless the context indicates otherwise. The Company has its principal executive offices at 10 East 40th Street, New York, New York 10016, telephone (212) 545-1900.\nDuring the first four months of fiscal year 1992, the Company was engaged in the financing, production and worldwide distribution of theatrical motion pictures and television programming, and the operation of motion picture theaters in the United Kingdom (the \"U.K.\"), the Netherlands and Denmark. The Company's business was conducted through its principal subsidiary, Metro-Goldwyn-Mayer Inc. (\"MGM\"), previously known as MGM-Pathe Communications Co. (\"MGM-Pathe\"). However, as described below, the Company's ownership of 98.5% of the common stock of MGM, which constituted substantial- ly all of the Company's assets, was sold through a foreclosure auction due to the Company's default on its then existing indebtedness. As a result, the Company no longer had any operating assets or sources of income.\nThe Company's predecessor-in-interest, The Cannon Group, Incorporated (\"Cannon\") was incorporated in New York on October 23, 1967. Subsequently, Cannon effected a merger into the Company, which was effective under New York law on November 25, 1985. In May 1992, the Company took additional actions in Delaware to correct certain deficiencies under Delaware law with respect to such merger. In 1987, in connection with a financial restructuring of the Company, Giancarlo Parretti or certain of his affiliates became the largest stockholders of the Company, assuming control of the Company. In 1988, Florio Fiorini or certain of his affiliates acquired equity ownership in the Company. Mr. Fiorini was then elected Chairman of the Board and exercised joint control with Mr. Parretti in managing the affairs of the Company. (See Item 1 \"Business--Changes in Corporate Control\".)\nOn November 1, 1990, the Company acquired MGM/UA Communications Co. (\"MGM/UA\") by means of a merger (the \"Merger\") of a wholly-owned subsidiary of the Company into MGM/UA. MGM/UA, the surviving corporation in the Merger, became a wholly-owned subsidiary of the Company and changed its name to MGM-Pathe Communications Co. Immediately thereafter, pursuant to an agree- ment entered into in connection with the Merger, MGM-Pathe acquired all of the outstanding capital stock of Pathe Entertainment, Inc. (\"PEI\") and Cannon Entertainment, Inc. (\"CEI\"), the two principal subsidiaries of the Company, and concurrently paid off all existing indebtedness of PEI and CEI to the Company.\nAs a result of the restructuring described above, the Company became a holding company operating exclusively through its subsidiaries. Prior to the foreclosure on the Company's shares of MGM common stock described below, the Company's business activities consisted of two business segments, filmed entertainment and theater operations. Since such foreclosure, the Company has engaged in no ongoing business operations and cannot predict whether it will do so in the future.\nCLBN has to date continued to make advances to the Company to permit the Company to satisfy its various expenditure requirements and debt payment obligations; however, there can be no assurance that CLBN will continue to make such advances. (See Item 7 \"Management's Discussion and\nAnalysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\".)\nAs of May 5, 1992, immediately prior to the foreclosure and tender offer described below, the Company owed CLBN an aggregate amount of approxi- mately $140 million, all of which was in default and overdue and payable. Also as of such date, MGM-Pathe owed CLBN an aggregate amount of approxi- mately $568 million, which indebtedness was in default and all but approximately $145 million of which was payable on demand. At such time, CLBN had the power, in its absolute discretion, to decide whether to advance additional funds to the Company and/or to pursue various remedies available to it based upon the Company's default, which remedies included, among other things, foreclosure upon the MGM-Pathe shares, which constituted virtually all of the assets of the Company. As discussed below, CLBN foreclosed on the Company's MGM-Pathe shares and completed a tender offer for the outstanding and unencumbered shares of the Company's common stock and the then outstanding debt securities.\nCHANGES IN CORPORATE CONTROL - EXTRAORDINARY EVENTS\nAs further described in the Form 10-K for fiscal 1991 of the Company and in Item 3 \"Legal Proceedings\", beginning in June 1991, the Company experienced a change in corporate control. As a result of this change, CLBN in its capacity as voting trustee of the Company's common stock acquired the power to designate all of the members of the Board of Directors of the Company.\nIn April, 1991, in connection with the extension of credit by CLBN to the Company, Melia International N.V., a Netherlands corporation (\"Melia\") and certain of Melia's stockholders and subsidiaries including the Company, (i) guaranteed certain obligations of MGM to CLBN and (ii) pledged to CLBN all shares (including additional shares, if any, to be issued) of the Company and MGM, respectively, owned by such entities (pursuant to the \"PCC Pledges\" and \"MGM Pledge\", respectively) to secure all indebtedness owing by the Company, MGM, Melia and their affiliates to CLBN (the \"Secured Obligations\"), and (iii) placed all of the shares of the Company and MGM owned by such entities (including additional shares, if any, to be issued) under irrevocable voting trust agreements (the \"PCC Voting Trusts\" and the \"MGM Voting Trust\") in favor of CLBN. The shares covered by these pledge agreements and/or voting trust agreements represented approximately 89.3% of the outstanding common stock of Pathe and 98.5% of the outstanding common stock of MGM. Such voting trust agreements were initially held in escrow until CLBN broke such escrow as a result of certain actions by Mr. Parretti, the then Chairman of the Board of the Company.\nUpon breaking the escrow, CLBN exercised its voting powers by written consent pursuant to the MGM Voting Trust, and subsequently pursuant to the MGM Pledges, to remove Parretti and certain other then directors of MGM. The validity of the exercise of such voting rights was confirmed by the Court of Chancery for the State of Delaware in and for Newcastle County on December 30, 1991 (all such related litigation is herein referred to as the \"MGM Proceedings\").\nOn July 8, 1991, CLBN, exercising its voting rights pursuant to the PCC Pledges, acted by written consent to remove the directors of the Company. On March 23, 1992, a final order was entered by the Delaware Chancery Court stipulating that the Directors of the Company who had not resigned had been properly removed by CLBN's actions on July 8, 1991.\nOn February 3, 1992, at a meeting of the newly-expanded Board of Directors of the Company, Messrs. Ladd and Stanfill were each elected Co-Chairman of the Board of Directors and Co-Chief Executive Officer of the\nCompany, Charles R. Meeker was elected President and Treasurer of the Company and certain other new officers were elected.\nDuring the first quarter of 1992, the Company was in default on its indebtedness to CLBN, which indebtedness was secured by, among other collat- eral, all of the Company's shares of MGM common stock. At such time, CLBN had the power, in its absolute discretion, to decide whether to advance additional funds to the Company and/or to pursue various remedies available to it based upon the Company's default, which remedies included, among other things, foreclosure upon the MGM shares, which constituted virtually all of the assets of the Company. In exercising the remedies available to it, on April 16, 1992, CLBN commenced a foreclosure action (the \"Foreclosure\") with respect to the 98.5% of outstanding common stock of MGM owned by the Company (the \"Company's MGM Shares\").\nOn April 16, 1992, the Board met and formed a special committee (the \"Special Committee\"), to review, consider and evaluate the Foreclosure and its effect on the Company and its subsidiaries and to advise and make appropriate recommendations to the Board as to the Company's response to the Foreclosure. The Special Committee retained an independent financial adviser and independent legal counsel.\nIn a letter dated April 17, 1992 to the Special Committee, CLBN indicated its belief that any attempt on the part of the Company or holders of the Company's equity and debt securities to forestall or delay the Foreclosure would be harmful to the interests of all parties. CLBN also expressed its willingness to negotiate with the Company with respect to certain benefits to be provided to the holders of the Company's equity and debt securities in connection with the Foreclosure, including by (i) providing credit support for a then to be determined portion of the principal and interest on (x) the then outstanding 12-3/8% Senior Subordinated Notes Due 1994 (the \"12-3/8% Notes\"), (y) the then outstanding 8-7/8% Convertible Senior Subordinated Debentures due April 15, 2001 (the \"8-7/8% Debentures\") and (z) the then outstanding 12-7/8% Senior Subordinated Debentures due April 15, 2001 (the \"12-7/8% Debentures\", and, collectively with the 12-3/8% Notes and the 8-7/8% Debentures, the \"Company Bonds\" or \"Bonds\") and (ii) making a tender offer for a then to be determined number, and at a then to be determined price per share, of the outstanding unencumbered shares of Company common stock.\nDuring the weeks of April 20, 1992 and April 27, 1992, the Special Committee, the Company, CLBN, certain holders of the Company Bonds, the trustees under the indentures pursuant to which such Bonds were issued and various financial and legal advisors negotiated with respect to the type of credit support to be provided for the Company Bonds.\nIn these negotiations, the Company expressed a strong preference for a cash payment to the holders of its debt and equity securities. Following these negotiations between the Special Committee and representatives of CLBN, the Board of the Company met on May 1, 1992.\nThe three directors of the Company affiliated with CLBN withdrew from the meeting prior to the presentation of the Special Committee. The Special Committee presented a draft of the Company Agreement (as defined below) and recommended that the Board approve the form of the Company Agreement. The remaining directors unanimously approved the recommendation of the Special Committee and, in view of the fact that three directors were employees of CLBN or Credit Lyonnais and that the remaining directors were all officers of the Company and also officers and employees of MGM, the Board decided to express no opinion with respect to any offer by CLBN for securities of the Company.\nBy a letter dated May 1, 1992, by and between the Company and CLBN (the \"Company Agreement\"), the Company agreed to take no legal action to forestall or delay the Foreclosure, in consideration for which CLBN agreed to make a tender offer for up to 5,800,000 shares of the common stock of the Company, par value $0.01 (the \"Shares\") at $1.50 per Share, net to the Seller in cash (the \"Equity Offer\"), and for all of the Company Bonds, to fund certain past due interest on the Company's outstanding debt securities and to provide funding to enable the Company to satisfy its obligations with respect to interest on such debt securities, not owned by CLBN, through May 5, 1993. In connection with such offer, CLBN agreed to purchase the 12-3/8% Notes at $470 per $1,000 principal amount, the 12-7/8% Debentures at $470 per $1,000 principal amount and the 8-7/8% Debentures at $420 per $1,000 principal amount (collectively the \"Debt Offers\").\nOn May 5, 1992, CLBN and certain holders of certain Company Bonds (the \"Holders\") executed a Securities Purchase Agreement (the \"Securities Purchase Agreement\"), pursuant to which the Holders agreed to sell, and CLBN agreed to purchase, immediately following the Foreclosure, approximately $27 million in aggregate principal amount of such Company Bonds at the same price as under the Debt Offers. Additionally, the Holders agreed to tender any Company Bonds thereafter acquired by them until such time as the Debt Offers closed.\nOn May 1, 1992, CLBN sold and assigned $483,489,000 of the Secured Obligations (the \"Assigned Obligations\") to MGM Holdings Corporation (\"MGM Holdings\"), a Delaware corporation and a wholly-owned subsidiary of Credit Lyonnais S.A. (\"Credit Lyonnais\"). The sale of the Company's MGM Shares at an auction sale (the \"Auction\") was held as scheduled on May 7, 1992, and MGM Holdings, as the only bidder, acquired ownership of the MGM Shares. In consideration for the MGM Shares, MGM Holdings bid-in the Assigned Obligations.\nFollowing the Foreclosure, on May 7, 1992, CLBN commenced the Equity Offer on the terms and subject to the conditions set forth in an Offer to Purchase and in the accompanying Letter of Transmittal (collectively, the \"Equity Offer Documents\") filed with the Securities and Exchange Commission (the \"Commission\") in a Schedule 13E-3 on May 7, 1992. In the Equity Offer, Shares which were subject to security interests, liens, pledges, encumbrances, mortgages, claims, hypothecations or voting trust arrangements (collectively, \"Encumbrances\") were not accepted for payment. Approximately 94% of the issued and outstanding shares of common stock of the Company were owned by Melia, Renta Inmobliara International B.V. (\"Renta B.V.\"), Renta Corp. (\"Renta Corp.\", and collectively with Renta B.V., the \"Rentas\") and Comfinance S.A., and were subject to the PCC Pledge and PCC Voting Trusts. In addition, Viajes Melia S.A. (\"Viajes\"), an affiliate of Melia, owned approximately 0.7% of the shares of common stock of the Company, and were subject to a PCC Voting Trust in favor of CLBN. Since the Shares beneficially owned by Melia, the Rentas, Comfinance and Viajes were subject to Encumbrances in favor of CLBN, such Shares were not tendered in connection with the Equity Offer.\nThe 5,800,000 Shares which CLBN offered to purchase through the Equity Offer constituted approximately 97% of the maximum number of Shares outstanding on May 1, 1992 which could qualify as Shares not subject to Encumbrances (\"Unencumbered Shares\"), and approximately 10% of the total number of Shares outstanding as of May 1, 1992 and approximately 5% of the aggregate number of such Shares and the Additional Shares, on such date.\nIn conjunction with the Equity Offer, on May 8, 1992, CLBN commenced the Debt Offers to purchase all of the then outstanding Company Bonds at the purchase prices noted above, in each case net to the seller in cash upon the terms and subject to the conditions set forth in the Offer to Purchase and Consent Solicitations (the \"Debt Offer Documents\") relating to\nthe respective Company Bonds. Consent Solicitations relating to the respective Company Bonds required affirmative consents (the \"Consents\") by the holders of at least a majority in principal amount of such Bonds outstanding under the respective Indentures to adopt certain amendments (the \"Proposed Amendments\") in the form of supplemental indentures to the res- pective Indentures for each of the 12-3/8% Notes, the 8-7/8% Debentures and the 12-7/8% Debentures (the \"Supplemental Indentures\"), as contemplated in the Debt Offer Documents. The Supplemental Indentures amended the Indentures so that (i) certain of the 12-7/8% Debentures and 8-7/8% Debentures (collectively, the \"Debentures\") previously acquired by the Company were to be used to satisfy any repayment obligation arising from the Company's failure to satisfy the minimum net worth covenant; (ii) any corporation into which the Company may merge or to which the Company may sell substantially all of its assets is no longer required to assume the obligations of the Company under the Indentures; (iii) any Debentures owned by CLBN will be counted in determining whether the holders of the required principal amount of Debentures have concurred in any direction, waiver or consent; and (iv) any Defaults (as defined in the Indentures) waivable under the Indentures are waived.\nAs described above, pursuant to the Securities Purchase Agreement, holders of approximately 66% of the aggregate outstanding principal amount of the debt securities issued under the Indenture dated as of April 15, 1986 between the Company and Chemical Trust Company of California (formerly Manufacturers Hanover Trust Company of California and herein, \"Chemical Trust\"), under which both 8-7/8% Debentures and certain of the 12-7/8% Debentures were then outstanding (the \"8-7/8% Debenture Indenture\") and holders of approximately 55% of the debt securities issued under the Indenture dated as of April 15, 1986 between the Company and Chemical Trust under which certain of the 12-7/8% Debentures were then outstanding (the \"12- 7/8% Debenture Indenture\") consented to the Proposed Amendments to their respective Indentures.\nAs a result of the Equity Offer, CLBN acquired 2,809,739 Shares of the Company. As a result of the Debt Offers, (a) $2,856,000 in aggregate principal amount of the 12-3/8% Notes, $625,000 in aggregate principal amount of the 8-7/8% Debentures and $5,898,000 in aggregate principal amount of the 12-7/8% Debentures (including $2,345,000 principal amount of those 12-7/8% Debentures previously converted from the originally issued 8-7/8% Debentures) were tendered and accepted in the Debt Offers and (b) together with the Consents received pursuant to the Securities Purchase Agreement, the total percentage of Consents received relating to the 12-3/8% Notes Indenture was 49.7%, the total percentage of Consents received relating to the 8-7/8% Debentures Indenture was 82.1% (such Consents consisting of Consents relating to both 8-7/8% Debentures and those 12-7/8% Debentures that were converted 8-7/8% Debentures and which were governed by the 8-7/8% Debenture Indenture) and the total percentage of Consents received relating to the 12-7/8% Debentures Indenture was 77.5%, in each case with respect to the total aggre- gate amount of Bonds outstanding under each respective Indenture. On May 29, 1992, as a result of the performance of the agreements in the Securities Purchase Agreement, the Company announced that it had received a sufficient number of Consents with respect to the 8-7/8% Debenture Indenture and 12-7/8% Debenture Indenture, and that Supplemental Indentures to each such Indenture had been executed.\nIn July, 1992, an additional $100,000 in aggregate principal amount of 12-3/8% Notes were acquired by CLBN and in connection therewith Consents were received with respect to the 12-3/8% Note Indenture so that, together with Consents received previously, the total percentage of Consents received relating to the 12-3/8% Notes was 50.3% of the total outstanding. The Company is currently arranging for the execution of the Supplemental Indenture to the 12-3/8% Note Indenture.\nThe effect of the Equity Offer was to cause the Shares to no longer be eligible for listing on the New York Stock Exchange (the \"NYSE\") and to be subject to termination of registration under the Securities and Exchange Act of 1934, as amended (the \"Exchange Act\").\nTrading of the Company's common stock was suspended by the NYSE on July 13, 1992 pending application by the NYSE to the Commission to delist the Shares for failure to meet certain listing criteria. Such action was taken because the Company had fallen below the NYSE's continued listing criteria relating to (i) net tangible assets available to common stock together with three-year average net income and (ii) aggregate market value of publicly- held common stock. On August 28, 1992, the Commission, in response to the NYSE's application, issued an order removing the Company's common stock from listing and registration on the NYSE.\nAs of March 18, 1994, there were 1,485 holders of record and approximately 3,191,936 Shares were held by stockholders other than officers, directors, and members of their immediate families and concentrated holdings of 10% or more.\nThe Company is unable to predict at this time whether any public market will exist for the Company's remaining outstanding shares of common stock. The Company does not have any present plans that would result in the repurchase or redemption of its common stock or in the admission for trading of such stock on other exchanges or markets.\nThe Company's stock continues to be subject to deregistration with the Commission if the Company has less than 300 stockholders of record, in which event the Company would no longer file public reports with the Commission.\nOn August 5, 1992, Mr. Meeker was elected President and Treasurer of the Company. Effective October 6, 1992, Alan Ladd, Jr. and Dennis Stanfill each resigned as Co-Chairman of the Company and Rene-Claude Jouannet was elected Chairman of the Company on November 23, 1992. On November 23, 1992, Guy Etienne Dufour and Bahman Naraghi resigned as directors of the Company. Effective as of May 5, 1993, Fredric S. Newman was elected a director of the Company. Effective as of May 6, 1993, Mr. Newman was elected President, Secretary and Treasurer of the Company, Messrs. Meeker and Jouannet resigned as directors of the Company and Mr. Newman became the sole director and the sole officer of the Company.\nEMPLOYEES\nAs of March 25, 1994, the Company had no employees.\nITEM 2.\n\n\nITEM 2. PROPERTIES\nNone.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\nVarious legal proceedings involving alleged breaches of contract, antitrust violations, copyright infringements and other claims relating to the film entertainment business of the Company are now pending, which proceedings the Company considers to be routine.\nThe Company is subject to a consent decree (the \"Consent Decree\") entered in the United States District Court for the Central District of California (\"California District Court\") in a Securities and Exchange\nCommission civil action commenced against the Company on November 19, 1987, entitled Securities and Exchange Commission v. The Cannon Group. Inc. et al., Case No. 87-07590. This proceeding against the Company and certain of its former directors and officers alleged, among other things, violations or aiding and abetting of violations of the antifraud, reporting, proxy, record keeping and internal controls provisions of the federal securities laws. Without admitting or denying the allegations in the Commission's complaint, the Company and certain individuals settled the action and consented to the entry of a final judgment enjoining them from violating the aforementioned provisions of the federal securities laws.\nThe Consent Decree required the Company to appoint an independent person to examine transactions between the Company and related parties for the period January 1, 1984 through December 31, 1986. The independent person is required to deliver a report to the Company's Board of Directors regarding such transactions together with recommendations regarding what action the Board should take as a result of the examination. The Company appointed a law firm as the independent person. In November 1991, the independent person resigned without having delivered a report to the Board of Directors. In its resignation letter, the independent person stated it had been unable to complete their examination because of the Company's failure to pay the independent person's fees and because certain members of the former management of the Company had failed to cooperate in the examination.\nCurrent management also believes that the Company under prior management may have violated other provisions of the Consent Decree. Violations of the Consent Decree could result in further proceedings by the Commission. If the Company were found to have violated the Consent Decree, the Company could be held in contempt of court and could be subjected to substantial penalties. The Company has informed the Commission of its concerns regarding compliance with the Consent Decree and is cooperating with the Commission in its review of this matter. While no assurances can be given, management believes that any punitive measures which may be imposed as a result of violations of the Consent Decree would be imposed upon those persons responsible for such violations (as opposed to the Company's current management) and would not have a material adverse effect upon the Company.\nThe Commission is currently conducting an investigation into certain transactions effected by prior management of the Company. The Company is cooperating fully with the Commission in its investigation. The Company cannot presently determine what, if any, action the Commission might take as a result of its investigation.\nOn November 13, 1990, a complaint was filed in Los Angeles Superior Court against the Company, Cannon Pictures, Inc., Mr. Parretti, Fernando Cappuccio, Danny Dimbort, Lilliana Avincola, Edmund Hamburger and Theodore J. Cohen by plaintiffs William J. Immerman, and Salem Productions, Inc. The first amended complaint, served on January 2, 1991, alleged, inter alia, rescission, breach of contract, breach of the covenant of good faith and fair dealing, interference with contractual relationships, interference with pro- spective economic advantage, promissory fraud, fraud, negligent misrep- resentation, intentional infliction of emotional distress, libel and slander in connection with the termination of plaintiffs' employment contracts. The amended complaint sought compensatory damages, depending on the cause of action, from $250,000 to in excess of $1,000,000, and punitive damages of $5,000,000. The Company filed an answer denying all liability and setting forth various affirmative defenses. A settlement was reached among the parties and the action has been dismissed. The Company's portion of the settlement liability will be covered by insurance.\nOn January 22, 1991, Century West Financial Corporation (\"Century West\") filed a complaint in Los Angeles Superior Court against the Company, Renta Properties and others for breach of contract, breach of third party\nbeneficiary contract, bad faith denial of contract, breach of the implied covenant of good faith and fair dealing, and tortious interference with prospective economic advantage. Century West alleges that it acted as broker for the sale of 6420 Wilshire Boulevard and is owed a commission. Century West seeks compensatory damages in the amount of $470,000, interest thereon and punitive damages. A Third Amended Complaint was filed in this action on January 14, 1994. Cross-complaints have been filed against the Company, and the Company has filed cross-claims. In addition, the Company is advancing defense costs to a former employee and will indemnify him subject to an undertaking for reimbursement under certain circumstances. The Company intends vigorously to defend this action.\nOn June 18, 1991, a complaint was filed in the United States District Court for the Central District of California against the Company, MGM, Messrs. Parretti, Fiorini, Globus and Aurelio Germes and Maria Cecconi (Mr. Parretti's wife) on behalf of a purported class which acquired MGM's 13% Subordinated Debentures due 1996. On October 10, 1991, J. Phillip Williams, on behalf of a group of MGM bondholders, filed a complaint in the United States District Court for the Central District of California against the Company, MGM, CLBN and Mr. Parretti which alleges that the defendants violated U.S. securities laws, and conspired to deceive plaintiffs about MGM's financial condition, markets, and business prospects, thereby artificially inflating the price of MGM's securities. The complaint seeks unspecified damages. The Company answered the complaint on February 3, 1992. Limited discovery was conducted regarding class certification. On March 23, 1992, the court heard and denied Williams' motion for class certification. On May 18, 1992, the court denied Williams' motion for reconsideration. On July 22, 1992, another bondholder, Herbert Eisen, moved to intervene in the lawsuit. After limited discovery was conducted regarding intervention, the court granted Mr. Eisen's motion to intervene. On December 15, 1992, Mr. Eisen filed a complaint-in-intervention that mirrors the allegations in the Williams' complaint. The Company and MGM answered Eisen's complaint-in- intervention on December 29, 1992. On October 26, 1993, the parties entered into a Stipulation of Settlement which would dispose of this matter subject to Court approval. The settlement, if approved, would create a fund of $4,500,000 against which injured class members may make a claim. Any unclaimed portion of the fund will be returned to the contributing defendants. The Company and MGM have funded the settlement.\nOn September 25, 1991, Century Insurance Ltd. (\"Century\") filed a complaint in Superior Court against the Company, MGM, Melia, Comfinance S.A. (\"Comfinance\"), CLBN and Mr. Parretti alleging, among other things, breach of contract, fraud, constructive fraud, conversion and conspiracy. The claims arise out of certain defendants' failure to pay a purported $1.75 million premium in connection with plaintiff's purported issuance of a completion guarantee bond in connection with the financing of the Merger and alleged unpaid premiums in connection therewith. The plaintiff seeks $34,200,000 in alleged management fees on three purported insurance investment bonds and declaratory relief. MGM was voluntarily dismissed from the action on January 3, 1992. The plaintiff served a second amended complaint on February 3, 1992. In addition, on December 6, 1991, this case was consolidated with an earlier declaratory relief suit filed by CLBN against Century. The Company was not a party to this earlier suit. On February 3, 1993, the court dismissed with prejudice Century's complaint against the Company and all of the other defendants, for failure to comply with discovery orders. On July 14, 1993, Century moved to vacate the judgment in the Company's and other defendants' favor, which motion was denied. Century has filed a notice of appeal of denial of its motion to vacate. The parties have not completed the appeal briefing and no date has been set for the hearing of the appeal.\nOn January 18, 1991, Andrea Kune, a stockholder of the Company, filed a derivative lawsuit on behalf of the Company against Messrs. Parretti, Fiorini, Globus, Valentina Parretti, Ms. Cecconi, Antonio Pares-Neira and\nLewis P. Horwitz, alleging breach of fiduciary duty, abuse of control, waste of corporate assets, fraud and deceit, negligent misrepresentation and constructive fraud. Certain other individuals formerly associated with the Company were subsequently named as defendants. The Company was named as a nominal defendant only. On September 16, 1991, the Company filed a Statement of Non-Response asserting that it had no obligation to respond to the complaint because the complaint seeks no relief from the Company. A second amended complaint was filed on July 27, 1992 against the same defendants in which the Company was again named as a nominal defendant. Kune alleges claims for breach of fiduciary duty, fraud and deceit, negligent misrepresentation and constructive fraud against the defendants. The amended complaint seeks unspecified damages. The Company remains a nominal defendant only and no claims for monetary relief are asserted against it.\nOn January 8, 1992, Fabio Serena, a former employee of the Company, filed a lawsuit in Los Angeles Superior Court against the Company. The complaint contained causes of action for (1) breach of contract; (2) breach of covenant of good faith and fair dealing; (3) promissory fraud; (4) fraud; (5) intentional infliction of emotional distress; and (6) negligent infliction of emotional distress. The complaint also sought in excess of $6,750,000 in compensatory damages, and $10,000,000 in punitive damages, in addition to costs of the suit and interest. The Company successfully demurred to Plaintiff's Complaint, as well as Plaintiff's first amended complaint and his second amended complaint. All of the Plaintiff's claims were dismissed with the exception of one cause of action for breach of contract which sought damages \"in excess of $1,000,000,\" together with interest and costs of suit. A confidential settlement was agreed in December, 1993, pursuant to which the case was dismissed with prejudice.\nOn January 27, 1992, Linda Carter filed an application for award for employer violation of Section 132(a) of the Labor Code before the Workers' Compensation Appeals Board of the State of California against the Company and MGM seeking reinstatement of employment, back wages at approximately $21,000 per year plus benefits, and costs of suit. The application alleges Ms. Carter was laid off on March 4, 1991, in retaliation for filing a workers' compensation claim. The Company is vigorously defending this action.\nOn January 21, 1992, CLBN filed an action in the Delaware Chancery Court in which CLBN asserted various claims against the Company, Gestione Nuove Attivita Finanziarie S.a.r.l. (a company controlled by Ms. Cecconi) (\"GENAF\"), Melia and certain subsidiaries of Melia seeking, among other things, a judicial declaration that: (i) a purported transfer of common stock of the Company from Melia and certain of its subsidiaries to GENAF (the \"Subject Stock\") is null, void and without effect; and (ii) the Company should issue new stock certificates to CLBN representing the Subject Stock or impose a constructive trust on the Subject Stock held by GENAF. On February 4, 1992, the Delaware Chancery Court issued an order sequestering the Subject Stock. The Company, Melia and its subsidiaries have answered the complaint. In addition, Melia has filed a third-party complaint seeking damages and injunctive and declaratory relief against GENAF, Mr. Parretti and Ms. Cecconi alleging, among other things, fraud and conversion. On or about February 6, 1992, Mr. Parretti and GENAF applied to the Civil Court in Rome for the appointment of a custodian of issued shares in the Company and MGM purpor- tedly held by Mr. Parretti and GENAF and for precautionary measures to protect the assets of the Company and MGM against further alleged diminution in value being caused by CLBN. The Court on or about February 24 and March 6, 1992 issued temporary ex parte orders decreeing that the shares of the Company and MGM are validly within the custody of the Court, and appointing Paolo Picozza as custodian of the shares in dispute. With consent of the court of March 6, 1992, Mr. Picozza purported to take action to amend Pathe's By-Laws to increase the number of directors of the Company to thirty and to appoint eight additional directors of the Company. Mr. Picozza also\npurported to take action to remove the current directors of MGM and to replace them with seven new directors. On March 12, 1992, CLBN filed a special appearance with the Court objecting to the decrees on the ground, among other things, that the stock certificates presented to the Court as evidence of Mr. Parretti's controlling interest in the Company and MGM were either already sequestered by the Delaware Chancery Court on February 12, 1992, pursuant to an order of that court dated February 4, 1992 or previously certified lost and replaced, as well as on various procedural and jurisdictional grounds. A hearing was held on Friday, March 20, 1992 regarding CLBN's special appearance. On March 18, 1992, Mr. Parretti and GENAF filed an appeal with the Italian Supreme Court on jurisdictional issues and CLBN filed a counter appeal (no hearing has so far been fixed by the Supreme Court). A new temporary order was rendered on April 28, 1992 con- firming the two earlier decisions. The April 28, 1992 order provided for an 180 day time period during which Mr. Parretti and GENAF should bring an action on the merits. On October 18, 1992, Mr. Parretti filed an action for damages against CLBN and the first hearing was scheduled for March 22, 1993. The case is, however, suspended until the Italian Supreme Court has rendered its decision on the jurisdictional issues.\nOn May 6, 1992, Robert Solomon filed a complaint in Delaware Chancery Court against the Company, CLBN, Dennis Stanfill, Alan Ladd, Jr., Mr. Meeker, Kenneth Meyer, Jay Kanter, William Jones, Thomas Carson, Rene Claude Jouannet, Bahman Naraghi, Guy Etienne Dufour, G. Goirand and Jacques Bertholier for breach of defendants' duties of fair dealing and breach of fiduciary duties to the public stockholders of the Company in connection with the Foreclosure and CLBN's Tender Offer for the Company's stock at a price of $1.50 per share. Plaintiff filed the action on his own behalf and as a class action on behalf of a purported class of public stockholders of the Company. On March 15, 1994, Solomon filed an amended class action complaint against the Company, CLBN and certain of the previously named individuals. Although the Company is still studying the Amended Complaint, no monetary relief is sought against the Company. The Company plans vigorously to defend the action.\nOn December 7, 1992, MGM filed an action against Tracinda Corporation, Jeffrey Barbakow, Kirk Kerkorian, Stephen Silbert (the \"Kerkorian Defendants\") and Houlihan, Lokey, Howard & Zukin, Inc. (\"HLHZ\") in the Superior Court. On December 22, 1992, MGM filed an amended complaint which sets forth claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, breach of contract and negligence in connection with the sale of MGM to the Company in the fall of 1990. MGM alleges, among other things, that the Kerkorian Defendants engaged in a scheme to induce the independent members of MGM's Board to approve the merger to MGM's detriment. MGM seeks damages in an amount of $750,000,000, plus punitive damages according to proof at trial, and a declaration that the indemnity provisions of certain agreements executed in connection with the merger do not cover any judgment, settlement, fees or costs incurred by the Kerkorian Defendants in a legal action. On December 17, 1992, the Kerkorian Defendants filed an answer denying the allegations of the complaint and a cross-complaint against MGM for breach of contract, tortious bad faith, breach of indemnification agreements, equitable indemnity and declaratory relief. The cross-complaint seeks damages according to proof at trial, exemplary damages, attorneys fees and costs. On January 27, 1993, HLHZ filed an answer denying the allegations of the complaint and a cross-complaint against MGM, the Company and CLBN for declaratory relief, fraud, negligent misrepresentation and equitable indemnity. The Company answered HLHZ's cross-complaint on March 29, 1993. HLHZ seeks, among other things, indemnification from the Company under the terms of an engagement letter between HLHZ and the Company and damages for fraud, negligent misrepresentation and equitable indemnity in an amount according to proof at trial, plus attorneys fees, costs and expenses. Discovery in this action has commenced. On October 13, 1993, a Special Referee in this matter recommended that the Court enter an order declaring\nthat the Company be required to advance to HLHZ its reasonable attorneys' fees in this matter pursuant to the engagement letter, subject to repayment if HLHZ were later found to have committed fraud. The Court did enter such an order, and the Company has moved for reconsideration of that decision. If upheld, such a declaration or order could result in the imposition of substantial liability and other obligations upon the Company, in an amount as yet undetermined but likely to be beyond the Company's present financial capabilities or otherwise materially adverse to the Company. The Court has stated that the matter will come on for trial in June, 1994. The Company is vigorously litigating these actions.\nOn April 16, 1993, the Company filed a bankruptcy petition against Melia with the Bankruptcy Chamber of the Amsterdam District Court. This petition was joined by the Dutch tax authorities, Scotti International N.V., Cannon Cinema B.V. and CLBN. At a hearing on April 27, 1993, the Court found that Melia had ceased to pay its debts and declared Melia officially bankrupt. The Court appointed Mr. R.W. De Ruuk as official receiver in the bankruptcy. The appeal period under the governing Dutch Bankruptcy Code has lapsed. Mr. De Ruuk has deposited three public reports with the Dutch authorities. It appears to the Company from such reports that no material recovery benefitting it will be forthcoming.\nOn June 29, 1993, Aurelio Germes, a former officer of the Company, filed a declaratory relief action against the Company. Mr. Germes seeks a declaratory judgment that the Company is obligated to pay Mr. Germes' legal fees in connection with the SEC investigation and in defense of the Kune matter. The Company filed an answer to this complaint on August 12, 1993. The Company intends to vigorously defend this action. Trial of the action is set for May 24, 1994.\nDemands for the advancement of legal fees and indemnification in the defense of the Kune and Williams actions have been made by Giancarlo Parretti, Maria Cecconi, and Valentina Parretti (collectively, the \"Parrettis\"). In addition, a demand for the advancement of legal fees for defense of the Kune case has been made by Yoram Globus. The Company has rejected these demands. A claim has also been made by the Parrettis' former attorneys in those cases for fees already incurred, in amounts totalling less than $100,000, and the Company is investigating this matter to determine, what, if any, liabilities it may have in respect of this claim. In addition, there have been additional claims for indemnification and/or the advancement of expenses and legal fees which have been asserted from time to time by former officers, directors and/or employees of the Company, and the Company reviews each demand on a case by case basis.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nPART II\nITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs a consequence of the tender offer described in Item 1 Business above, trading in the Company's common stock was suspended by the NYSE on July 13, 1992 pending application by the NYSE to the Commission to delist the Shares. Such action was taken because, as a result of the tender offer, the Company had fallen below the NYSE's continued listing criteria related to (i) net tangible assets available to common stock together with three-year average net income and (ii) aggregate market value of publicly-held common\nstock. On August 28, 1992, the Commission, in response to the NYSE's application, issued an order removing the Company's common stock from listing and registration on the NYSE.\nAs of March 18, 1994, there were 1,485 holders of record and approximately 3,191,963 Shares were held by stockholders other than officers, directors, and members of their immediate families and concentrated holdings of 10% or more.\nNo public market currently exists for the Company's remaining outstanding shares of common stock, and the Company is unable to predict at this time whether any public market will exist in the future. The Company does not have any present plans that would result in the repurchase or redemption of its common stock or in the admission for trading of such stock on other exchanges or markets.\nThe Company's stock continues to be subject to deregistration with the Commission if the Company has less than 300 holders of record, in which event the Company would no longer file public reports with the Commission.\nThe Company has never paid a dividend on its common stock. In addition, the Company's subordinated debt indentures contain covenants that limit the Company's ability to pay dividends. The Company's current credit agreement prohibits the payment of dividends. In light of the Company's current financial condition and state of operations, it does not anticipate any payment of dividends in the foreseeable future.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nPATHE COMMUNICATIONS CORPORATION Selected Financial Data (in thousands, except per share data)\nThe table below summarizes recent financial information of Pathe Communications Corporation. For further information, see the Company's Financial Statements and the notes thereto contained elsewhere herein.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Company's Financial Statements and related notes thereto. References to Notes are to the notes to such statements.\nGeneral\nAs a result of the Foreclosure on May 7, 1992 (see Note 3), the Company has no operating assets or sources of operating income (see \"Liquidity and Capital Resources\").\nResults of Operations\n1993 Versus 1992 Operations\nGeneral\nThe Company reported a net loss for 1993 of $(26,163,000), or $(.22) per common share as compared to a net loss of $(472,838,000), or $(4.05) per common share (a loss before extraordinary items of $(153,106,000) or $(1.31) per common share) for 1992, in both years based on 116,746,810 weighted average common shares outstanding.\nGeneral Corporate Administration Expenses\nGeneral corporate administration expenses increased $3,638,000 (approximately 52%) for 1993 due to payments in settlement of various litigation matters and accruals for legal fees and expenses related to other pending litigation matters.\nOther Income (Expense)\nThe equity in the net losses of subsidiaries of $(125,037,000) was eliminated for 1993 due to the Foreclosure (see Note 3.). Net interest expense decreased from $20,600,000 for 1992 to $15,838,000 for 1993 due primarily to a reduction in the average debt from CLBN (see Note 4).\nDuring 1993, the Company, CLBN, MGM and various other parties settled certain litigation matters filed by Keller Construction Company, by American Savings Bank, F.A., by Fabio Sevena and by Castro & Associates, Inc. The costs of these settlements were $1,250,000, $2,800,000, $300,000 and $37,500, respectively, of which the Company's shares were $1,000,000, $2,500,000, $300,000 and $30,000, respectively (see Note 9).\n1992 Versus 1991 Operations\nGeneral\nThe Company reported a net loss for 1992 of $(472,838,000), or $(4.05) per common share (a loss before extraordinary items of $(153,106,000), or $(1.31) per common share) as compared to a net loss of $(352,935,000), or $(3.02) per common share for 1991, in both years based on 116,746,810 weighted average common shares outstanding.\nGeneral Corporate Administration Expenses\nGeneral corporate administration expenses decreased $6,530,000 (approximately 48 percent) during 1992, mainly due to reduced salaries and overhead charges, and a decrease in litigation costs and fees.\nOther Income (Expense)\nThe Company's equity in the net losses of subsidiaries represents its 98.5 percent share in the losses of MGM through May 7, 1992, the date of the Foreclosure (see Note 3). In 1991, such amount reflected a full year of MGM's losses. Due to the Foreclosure, a loan to an affiliate relating to the funding of the Company's common stock subscriptions has been written off.\nNet interest expense was $20,602,000 and $30,805,000 in 1992 and 1991, respectively. The net decrease is due to the reduction of the Company's borrowings with CLBN (see Note 4) and lower interest rates during 1992.\nOther expense during 1991 includes reserves related to the write- off of advances and loans to certain affiliates.\nExtraordinary Items\nThe Company recorded an extraordinary loss in 1992 of $319,732,000 on its investment in MGM due to the Foreclosure (see Note 3).\nLiquidity and Capital Resources\nThe Company is currently dependent on CLBN for additional capital to fund its cash requirements. CLBN may, in its absolute discretion, decide whether to advance additional funds to the Company (see Note 4). Additionally, the Company is in default on its existing indebtedness to Sealion (see Note 4).\nIn connection with the tender offer (see Note 5), CLBN agreed to provide funding to the Company to enable it to make scheduled interest payments under the Company's subordinated debenture agreements during the period ended May 5, 1993 on such obligations not owned by CLBN. Subsequent to May 5, 1993, CLBN has provided the Company with the funds necessary to meet the Company's expenses, including interest expenses on the Company's subordinated debt not owned by CLBN, but CLBN has not indicated any intention to fund any of the Company's future expenses, no assurances can be given that CLBN will fund any such expenses and the Company has no other source of funding.\nThe Company's subordinated debt agreements contain cross acceleration provisions which generally provide that if holders of certain other debt of the Company accelerate the maturity of such debt, such acceleration would be a default with respect to the subordinated debt. If such event were to occur and certain notices are given under the various agreements and indentures, a substantial portion of the Company's subordinated debt could be accelerated. The Company has not received any such notices.\nThe Company currently does not meet the minimum net worth covenant under its 12-7/8% and 8-7/8% debenture Indentures as its net worth has been below $37,500,000 for more than two consecutive quarters. Upon the occurrence of such event, such Indentures, as amended (see Note 5), require the Company to redeem 10 percent of the aggregate principal amount of the debentures then outstanding (at 100 percent of the principal amount) plus accrued interest by the last day of the following quarterly period. Similar payments must be made semi-annually thereafter until all outstanding debentures are redeemed, unless the net worth is above $37,500,000 as of the last day of any subsequent quarter. The Company can satisfy the redemption requirement through previously acquired and canceled debentures. Due to the significant amount of such debentures previously acquired by the Company, the Company will not be required to make any cash redemptions for the foreseeable future.\nRestriction on the Issuance of New Equity Securities\nIn connection with the funding of certain stock subscription agreements entered into concurrent with the acquisition of MGM, the Company, Melia and Comfinance entered into an agreement which prevents the Company from selling shares of the Company, except for shares held by certain companies controlled by prior management, until certain bank debt of such companies (approximately $110,000,000) has been repaid. The agreement also set a minimum price for the sale of such shares and directed the proceeds to be used to repay this bank debt. In May 1991, this Agreement was amended to allow the Company to sell stock of the Company, subject to CLBN's approval of both the issuance of the stock and of the sales price for the stock. The proceeds from any such issuance are required to be applied to the repayment of the Company's CLBN debt.\nCommitments and Contingencies\nThe Company is a party to various lawsuits (see Item 3, \"Legal Proceedings\" and Note 9). A significant adverse judgment in one or more of the cases could have a material impact upon the Company's liquidity.\nImpact of Interest Rates\nAny significant increase in interest rates would have a substantial adverse effect on the Company's financial position.\nVideo Medien Pool Productions and Vertriebs GmbH Licensing Transaction\nDiscussion of the prior years' licensing transaction with Video Medien Pool Productions and Vertriebs GmbH (\"VMP\"), and the listing of all titles licensed and delivered, are incorporated herein by reference to the Company's Report on Form 10-K for the fiscal year ended December 31, 1992 (including the further references contained therein). The Company's current management has no knowledge of these transactions.\nThe Company is subject to a Consent Decree entered on November 19, 1987 which requires the Company to provide certain information on a quarterly basis concerning transactions with VMP. The Company is currently in default of its obligations under this consent decree. (See Item 3 above.)\nCannon International v.o.f. (\"CI\"), a subsidiary of the Company prior to the Foreclosure, is a party to a licensing agreement (\"Contract No. 42\"), which granted VMP video and television exploitation rights to a significant number of motion pictures for various German-speaking territories. Substantially all of the revenues due under Contract No. 42 were recognized by CI in 1986. The Company has previously reported the aggregate payments collected and due from VMP.\nIn August 1992, MGM, as successor owner of CI, reached a comprehensive settlement agreement (the \"1992 Settlement\") with VMP covering all claims and obligations related to Contract No. 42. In connection with the 1992 Settlement, CI (which is no longer a subsidiary of the Company) agreed to (i) refund certain license fees under Contract No. 42 to VMP of approximately $8,000,000; (ii) reimburse approximately $4,100,000 of VMP's settlements with third parties because VMP had licensed to them motion pictures previously licensed by CI to other parties; and (iii) make substitutions for certain of the motion pictures originally licensed to VMP.\nAs of December 31, 1992, CI has licensed 546 titles (the Company currently classifies all television episodes per series as one title; each episode was previously reported as a separate title) to VMP under Contract No. 42, of which 282 have been delivered to VMP. A third party dispute is\ncurrently blocking the delivery of an additional 228 titles. There are 36 titles still to be delivered by the Company.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPATHE COMMUNICATIONS CORPORATION\n(PARENT ONLY)\nAND FINANCIAL STATEMENT SCHEDULES\nAll other schedules are omitted since the required information is not applicable, not material or is included in the financial statements and notes therein.\nIndependent Auditors' Report\nThe Board of Directors Pathe Communications Corporation:\nWe have audited the financial statements of Pathe Communications Corporation (Parent only) (\"the Company\") as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs discussed in Note 9 to the financial statements, the Company is a defendant in numerous lawsuits claiming significant compensatory and punitive damages. The ultimate outcome of this litigation cannot presently be determined. Accordingly, provision for the ultimate liability that may result upon adjudication has not been recognized in the accompanying financial statements.\nThe accompanying financial statements have been prepared assuming the Company will continue as a going concern. As described in Note 1 to the financial statements, Credit Lyonnais Bank Nederlands (\"CLBN\") foreclosed on the Company's investment in Metro-Goldwyn-Mayer Inc., which constituted all the Company's operating assets and only source of income. In addition, all of the Company's bank indebtedness (see Note 4) is currently in default and any acceleration of such bank debt that could result from such defaults constitutes an event of default under the Company's bond indentures which may accelerate the maturity of the Company's subordinated debt at face value. The Company is currently dependent on the day-to-day financial support and forbearance of CLBN from which there is no commitment to continue making funds available to the Company. All of these conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nBecause of the effects on the financial statements of such adjustments, if any, as might have been required had the outcome of the uncertainties referred to in the two preceding paragraphs been known, we are unable to, and do not, express an opinion on the accompanying financial statements and financial statement schedules. As discussed in Note 7 to the financial statements, the Company changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109.\nKPMG Peat Marwick\nLos Angeles, California March 18, 1994\nPATHE COMMUNICATIONS CORPORATION (PARENT ONLY) NOTES TO FINANCIAL STATEMENTS\nNOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation. The financial statements of Pathe Communications Corporation (\"Pathe\" or the \"Company\") have been presented on a separate company (parent only) basis. Credit Lyonnais Bank Nederland N.V. (\"CLBN\") controls the voting rights with respect to approximately 97% of the Company's common stock. See Notes 5 and 6 regarding CLBN's acquisition of certain of the Company's subordinated debt and common stock. In May 1992, CLBN fore- closed on 59,100,000 shares constituting 98.5% of the common stock of Metro- Goldwyn-Mayer Inc. (\"MGM\"), which constituted substantially all of the Company's assets (see Note 3). Following the sale of its MGM stock, the Company has no operating assets or sources of income. The Company is currently dependent on CLBN to fund its ongoing cash requirements.\nPrior to July 1991, the Company engaged in significant transactions with its principal shareholders and certain affiliated companies.\nCash Equivalents. The Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents.\nDebt Issuance Costs. Debt issuance costs are capitalized when incurred, and together with original issue discount, are amortized over the term of the related debt utilizing the bonds outstanding method.\nReclassification. Certain 1992 and 1991 amounts have been reclassified to conform with the 1993 presentation.\nNOTE 2 - MARKET FOR THE COMPANY'S COMMON STOCK\nTrading in the Company's common stock was suspended by the New York Stock Exchange (the \"Exchange\") on July 13, 1992 pending application by the Exchange to the Securities and Exchange Commission (the \"SEC\") to delist the stock. Such action was taken because the Company had fallen below the Exchange's continued listing criteria related to (i) net tangible assets available to common stock together with three-year average net income and (ii) aggregate market value of publicly held common stock. On August 28, 1992, the SEC, in response to the Exchange's application, issued an order removing the Company's common stock from listing and registration on the Exchange.\nThe Company is unable to predict at this time whether any public market will exist for the Company's remaining outstanding shares of common stock. The Company does not have any present plans that would result in the repurchase or redemption of its common stock or in the admission for trading of such stock on other exchanges or markets.\nThe Company's stock may be subject to deregistration with the SEC if the Company has less than 300 stockholders of record, in which event the Company would no longer file public reports with the SEC.\nNOTE 3 - EXTRAORDINARY ITEM - LOSS ON FORECLOSURE\nOn April 16, 1992, CLBN commenced foreclosure proceedings (the \"Foreclosure\") upon 59,100,000 shares of MGM's common stock owned by the Company (the \"MGM Shares\"), representing 98.5% of the issued and outstanding common stock of MGM. In accordance with the Foreclosure, an auction to sell the MGM Shares was held on May 7, 1992 in Wilmington, Delaware. At such auction, MGM Holdings Corporation, an affiliate of CLBN (\"MGM Holdings\"), bid-in $483,489,000 of the indebtedness of the Company and certain affiliates, which indebtedness had previously been assigned by CLBN to MGM Holdings, and acquired all of the MGM Shares. The Company recorded an extraordinary loss of $319,732,000 in the year ended December 31, 1992, representing the difference between the carrying value of its investment in MGM and the amount of the Company's debt relieved in the Foreclosure.\nNOTE 4 - BANK AND OTHER DEBT\nCredit Facilities. The Company previously had a $100,000,000 multi-currency revolving credit facility (\"Credit Facility\") and a $250,000,000 interim revolving credit facility (\"Interim Facility\") with CLBN. Borrowings under both facilities bore interest at 2% over the higher of LIBOR or CLBN's cost of funds, payable quarterly. The Credit Facility expired on December 31, 1991 and the Interim Facility expired on January 31, 1992. On May 7, 1992, approximately $140,000,000 of indebtedness, including accrued interest, under the credit facilities was relieved in the Foreclosure (see Note 3). In October 1992, the outstanding balance due to CLBN was converted into a demand promissory note, with interest accruing quarterly at LIBOR (3.25% at December 3, 1993) plus 2%. Any future advances by CLBN will be made under the promissory note and are at the absolute discretion of CLBN. At December 31, 1993 and 1992, the Company had drawn down $23,412,000 and $9,814,000, respectively, under this facility. Interest expense related to this facility was $1,045,000 and $4,130,000 for the years ended December 31, 1993 and 1992, respectively.\nBank Note Payable. In November 1990, the Company borrowed $150,000,000 from Sealion Corporation N.V. (\"Sealion\"), a company affiliated with SASEA Holding S.A. (\"SASEA\"), which is affiliated with prior management of the Company, and lent the proceeds to Melia International N.V. (\"Melia\"), the Company's major stockholder. Sealion has assigned, as collateral security, its receivable from the Company to Credit Lyonnais S.A., the parent of CLBN. The Company's obligation is guaranteed by Melia and collateralized by approximately 51% of the Company's outstanding stock and by approximately 67% of the stock of MGM. The obligation bears interest at LIBOR (3.25% at December 31, 1993) plus 2% payable monthly and, as amended, requires principal reductions of $30,000,000 a month beginning in January 1992. None of these interest payments or principal reductions have been made by the Company, and this facility is currently in default. Interest expense related to this bank note was $7,864,000 in 1993 and $8,657,000 in 1992.\nMaturity Schedule. All of the foregoing debt is currently payable.\nNOTE 5 - SUBORDINATED DEBT\n12.375% Notes. The 12.375% senior subordinated notes (\"12.375% Notes\") were issued with detachable warrants to purchase 2,100,000 shares of common stock at $25 per share and are due in October 1994. An allocation of $10,500,000 of the $70,000,000 face amount of notes was made to the warrants, which resulted in a similar amount of the original issue discount. The unamortized discount was $380,000 and $785,000 as of December 31, 1993 and 1992, respectively.\n12.875% and 8.875% Debentures. The 12.875% senior subordinated debentures (\"12.875% Debentures\") and 8.875% convertible senior subordinated debentures (\"8.875% Debentures\") have been redeemable since April 15, 1989. On April 15, 1989, the Company, upon the exercise of an option by the 8.875% Debenture holders, repurchased $19,810,000 of the outstanding 8.875% Debentures and issued $28,550,000 of new 12.875% senior subordinated debentures, priced to yield the then current market rate on the existing 12.875% Debentures, which were trading at a substantial discount from face value. This transaction resulted in original issue discount on the new 12.875% Debentures of $8,740,000. The new debentures have terms similar to the existing 12.875% Debentures. The 12.875% Debentures and 8.875% Debentures are due April 15, 2001. The unamortized discount was $4,438,000 and $4,751,000 as of December 31, 1993 and 1992, respectively, on the 12.875% Debentures.\nAnnual sinking fund payments at 15% of the aggregate principal amounts of these debentures are required to commence in April 1996 through April 2000.\nTender Offer. On May 8, 1992, CLBN commenced a tender offer for all of the Company's outstanding 12.375% Notes, 12.875% Debentures and 8.875% Debentures at $470, $470 and $420 per $1,000 principal amount, respectively. CLBN acquired an aggregate principal amount of $9,379,000 pursuant to the tender offer, which expired on June 5, 1992.\nOn May 5, 1992, CLBN entered into an agreement with certain bondholders to purchase $27,013,000 face value of the foregoing obligations, which purchase was completed in May 1992.\nAt December 31, 1993, CLBN held an aggregate $42,488,000 of the foregoing obligations. Interest payments on the portion of those obligations which are still publicly held are being made by CLBN on the Company's behalf. Interest payments due on those obligations held by CLBN have been suppressed effective November 1, 1993 on the 12.375% Notes and October 15, 1993 on the 8.875% and 12.875% Debentures. At December 31, 1993, the Company has accrued approximately $2,700,000 due to CLBN for interest payments which have been suppressed on the foregoing obligations.\nRestrictive Covenants. The various subordinated debt indentures and note agreements contain various covenants including reporting requirements, dividend and stock purchase limitations and maintenance of minimum equity.\nThe agreements also contain cross acceleration provisions which provide that an event of default occurs if holders of certain other debt of the Company, in aggregate principal amount in excess of $1,000,000, accelerate the maturity of such debt and such acceleration is not rescinded within 60 days. While the Company is in default on many of these covenants, no such debt has been accelerated. If such event were to occur and certain notices are given under the various agreements and indentures, a substantial portion of the Company's subordinated debt could be accelerated. The Company has not received any such notices.\nIn connection with the tender offer, CLBN agreed to provide funding to the Company to enable it to make scheduled interest payments under the Company's subordinated debenture agreements during the period ended May 5, 1993 on such obligations not owned by CLBN after consummation of the tender offer. Subsequent to May 5, 1993, CLBN has continued to provide the Company with the funds necessary to meet the Company's expenses, including interest expenses on the Company's subordinated debt not owned by CLBN, but CLBN has not indicated any intention to fund any of the Company's future expenses and the Company has no other source of funding.\nIn conjunction with the tender offer, the indentures governing the 12.875% Debentures and 8.875% Debentures (the \"Indentures\") were amended to provide that (a) June 30, 1992 replaces December 28, 1985 as the date after which consolidated net income or loss will be included in the computation of permitted dividends, distributions or stock repurchases and (b) the minimum net worth covenant will be clarified to provide that certain debentures previously acquired by the Company and canceled can be utilized to satisfy any repayment obligation arising from failure to satisfy such covenant. Additionally, there were modifications to certain other covenants.\nThe Company currently does not meet the minimum net worth covenant under such Indentures as its net worth has been below $37,500,000 for more than two consecutive quarters. Upon the occurrence of such event, the Indentures, as amended as described above, require the Company to redeem 10% of the aggregate principal amount of the debentures then outstanding (at 100% of the principal amount) plus accrued interest by the last day of any subsequent quarter. As noted above, the Company can satisfy the redemption requirement through previously acquired and canceled debentures. Due to the significant amount of such debentures previously acquired by the Company, the Company will not be required to make any cash redemptions for the foreseeable future.\nMaturities. The scheduled maturities of the Company's subordinated debt over the next five years consist of $17,089,000 in 1994 and $34,885,000 after 1998.\nNOTE 6 - STOCKHOLDERS' EQUITY\nCommon Stock Subscriptions. On November 1, 1990, the Company entered into stock subscription agreements (\"Stock Subscriptions\") with two of its major shareholders, Melia and Comfinance S.A. (\"Comfinance\"), providing for the purchase of 57,000,000 shares of the Company's common stock at $10 per share, a total of $570,000,000.\nComfinance subscribed for 8,000,000 shares for a total of $80,000,000. In mid-November 1990, the Company loaned $50,000,000 to Comfinance; the Company understands that such funds were used by Comfinance to repay indebtedness it incurred to fund its Stock Subscription. Such indebtedness was offset against amounts owed by the Company to other European Interests.\nMelia subscribed for 49,000,000 shares for a total of $490,000,000. In November 1990, the Company loaned $150,000,000 to Melia (see Note 4) in connection with Melia's funding of its Stock Subscription. Melia's loan was satisfied (with accrued interest) in April 1991 by Melia's assumption of a like amount of the Company's indebtedness to CLBN.\nAdditionally, $50,000,000 of Melia's total Stock Subscription was funded on December 31, 1990, when a purported loan agreement was entered into with Banca Popolare di Novara (\"BPN\"). MGM reserved for the contested obligation as a loss due to the uncertainty of reimbursement or indemnification by SASEA if MGM were ultimately found to be liable under the purported loan agreement. However, because this purported loan was entered into in connection with the funding of Melia's Stock Subscription, the Company reclassified the remaining contested obligation (the original amount of $50,000,000 reduced by payments made by SASEA) as an offset to Common Stock Subscriptions at December 31, 1991. Due to the Foreclosure described in Note 3, the potential impact of this note on the Company ceased, resulting in an increase in the Company's investment in MGM and a corresponding increase to equity prior to the recognition of the extraordinary loss due to the Foreclosure.\nOn May 6, 1992, the Company issued 57,000,000 shares of common stock under the subscriptions to Melia and Comfinance. These shares are subject to pledge arrangements in favor of CLBN (see Note 1).\nTender Offer. On May 7, 1992, CLBN commenced a tender offer (the \"Tender Offer\") to purchase up to 5,800,000 of the Company's outstanding unencumbered shares of common stock (the \"Shares\") at $1.50 per share. The Tender Offer did not include 110,756,450 shares of the Company registered in the name of CLBN, as voting trustees under certain voting trust agreements or otherwise subject to pledge agreements in favor of CLBN. CLBN acquired 2,809,739 shares under the Tender Offer, which expired on June 5, 1992.\nLoss per Common Share. Per share data is based on 116,746,810 weighted average shares outstanding for 1993, 1992 and 1991.\nNOTE 7 - DOMESTIC AND FOREIGN TAXES\nDue to its limited activities, the Company has incurred no currently payable income tax liabilities.\nThe Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" during the year ended December 31, 1993. This statement requires the use of the liability method of accounting for deferred income taxes. The implementation did not have a material impact as all deferred tax assets were offset against valuation allowances as a result of loss carryforwards which are not expected to be realized.\nFor income tax reporting purposes the Company has available approximately $56,852,000 in federal net operating loss carryforwards on a parent only reporting basis. Additionally, the Company has available approximately $429,455,000 in capital loss carryforwards.\nIn periods prior to 1993, the provision for taxes has consisted solely of miscellaneous state franchise and other local license fees. Due to the nature of these items, for 1993 such expenses have been treated as general and administrative costs rather than as income tax expenses.\nNOTE 8 - RELATED PARTY TRANSACTIONS\nThe Company has various credit arrangements with CLBN (see Note 4). Interest of approximately $8,909,000 and $12,760,000 was charged on these facilities during 1993 and 1992, respectively. The Company also paid to CLBN ap- proximately $502,000 in 1992 related to letters of credit and other fees, pursuant to the terms of its credit facilities. No such fees were charged by CLBN to the Company during 1993.\nIn addition, CLBN was the holder of various subordinated notes and debentures issued by the Company. As the Company has no operating assets or significant sources of income, CLBN agreed during 1993 to forego its receipt of interest on the notes and debentures it holds (see Note 5).\nNOTE 9 - COMMITMENTS AND CONTINGENCIES\nLitigation. The Company is subject to a consent decree (the \"Consent Decree\") entered in the United States District Court for the Central District of California (\"California District Court\") in a civil action commenced by the SEC against the Company on November 19, 1987, entitled Securities and Exchange Commission v. The Cannon Group, Inc., et al., Case No. 87-07590.\nThis proceeding against the Company and certain of its former directors and officers alleged, among other things, violations or aiding and abetting of violations of the anti-fraud, reporting, proxy, record-keeping and internal controls provisions of the federal securities laws. Without admitting or denying the allegations in the SEC's complaint, the Company and certain individuals settled the action and consented to the entry of a final judgment enjoining them from violating the aforementioned provisions of the federal securities laws.\nThe Consent Decree required the Company to appoint an independent person to examine transactions between the Company and related parties for the period January 1, 1984 through December 31, 1986. The independent person is required to deliver a report to the Company's Board of Directors regarding such transactions together with recommendations regarding what action the Board should take as a result of the examination. The Company appointed a law firm as the independent person. In November 1991, the independent person resigned without having delivered a report to the Board of Directors. In its resignation letter, the independent person stated that it had been unable to complete its examination because of the Company's failure to pay the independent person's fees and because certain members of the former management of the Company had failed to cooperate in the examination.\nCurrent management also believes that the Company under prior management may have violated other provisions of the Consent Decree. Violations of the Consent Decree could result in further proceedings by the SEC. If the Company were found to have violated the Consent Decree, the Company could be held in contempt of court and could be subjected to substantial penalties. The Company has informed the SEC of its concerns regarding compliance with the Consent Decree and is cooperating with the SEC in its review of this matter. While no assurances can be given, management believes that any punitive measures which may be imposed as a result of violations of the Consent Decree would be imposed upon those persons responsible for such violations (as opposed to the Company's current management) and would not have a material adverse effect upon the Company.\nThe Commission is currently conducting an investigation into certain trans- actions effected by prior management of the Company. The Company is cooperating fully with the Commission in its investigation. The Company cannot presently determine what, if any, action the Commission might take as a result of its investigation.\nOn November 13, 1990, a complaint was filed in Los Angeles Superior Court against the Company, Cannon Pictures, Inc., Mr. Parretti, Fernando Cappuccio, Danny Dimbort, Lilliana Avincola, Edmund Hamburger and Theodore J. Cohen by plaintiffs William J. Immerman and Salem Productions, Inc. The first amended complaint, served on January 2, 1991, alleged, inter alia, rescission, breach of contract, breach of the covenant of good faith and fair dealing, interference with contractual relationships, interference with prospective economic advantage, promissory fraud, fraud, negligent misrepresentation, intentional infliction of emotional distress, libel and slander in connection with the termination of plaintiffs' employment contracts. The amended complaint sought compensatory damages, depending on the cause of action, from $250,000 to in excess of $1,000,000 and punitive damages of $5,000,000. The Company filed an answer denying all liability and setting forth various affirmative defenses. A settlement was reached among the parties and the action has been dismissed. The Company's portion of the settlement liability will be covered by insurance.\nOn January 22, 1991, Century West Financial Corporation (\"Century West\") filed a complaint in Los Angeles Superior Court against the Company, Renta Properties and others for breach of contract, breach of third party beneficiary contract, bad faith denial of contract, breach of the implied covenant of good faith and fair dealing, and tortuous interference with\nprospective economic advantage. Century West alleges that it acted as broker for the sale of 6420 Wilshire Boulevard and is owed a commission. Century West seeks compensatory damages in the amount of $470,000, interest thereon and punitive damages. A third amended complaint was filed in this action on January 14, 1994. Cross-complaints have been filed against the Company, and the Company has filed cross-claims. In addition, the Company is advancing defense costs to a former employee and will indemnify him subject to an undertaking for reimbursement under certain circumstances. The Company intends vigorously to defend this action.\nOn June 18, 1991, a complaint was filed in the United States District Court for the Central District of California against the Company, MGM, Messrs. Parretti, Fiorini, Globus and Aurelio Germes and Maria Cecconi (Mr. Parretti's wife) on behalf of a purported class which acquired MGM's 13% Subordinated Debentures due 1996. On October 10, 1991, J. Phillip Williams, on behalf of a group of MGM bondholders, filed an amended complaint against the Company, MGM, CLBN and Mr. Parretti which alleges that the defendants violated U.S. securities laws, conspired to deceive plaintiffs about MGM's financial condition, markets and business prospects, and thereby artificially inflated the price of MGM's securities. The complaint seeks unspecified damages. The Company answered the complaint on February 3, 1992. Limited discovery was conducted regarding class certification. On March 23, 1992, the Court heard and denied Williams' motion for class certification. On May 18, 1992, the court denied Williams' motion for reconsideration. On July 22, 1992, another bondholder, Herbert Eisen, moved to intervene in the lawsuit. After limited discovery was conducted regarding intervention, the Court granted Mr. Eisen's motion to intervene. On December 15, 1992, Mr. Eisen filed a complaint-in-intervention that mirrors the allegations in the Williams' complaint. The Company and MGM answered Mr. Eisen's complaint-in- intervention on December 29, 1992. On October 26, 1993, the parties entered into a Stipulation of Settlement which would dispose of this matter subject to Court approval. The settlement, if approved, would operate a fund of $4,500,000 against which injured class members may make a claim. Any unclaimed portion of the fund will be returned to the contributing defendants. The Company and MGM have funded the settlement.\nOn September 25, 1991, Century Insurance Ltd. (\"Century\") filed a complaint in Superior Court against the Company, MGM, Melia, Comfinance, CLBN and Mr. Parretti alleging, among other things, breach of contract, fraud, constructive fraud, conversion and conspiracy. The claims arise out of a failure to pay a purported $1,750,000 premium in connection with plaintiff's purported issuance of a completion guarantee bond related to the financing of the merger with MGM. The plaintiff seeks $34,200,000 in alleged management fees on three purported insurance investment bonds and declaratory relief. MGM was voluntarily dismissed from the action on January 3, 1992. The plaintiff served a second amended complaint on February 3, 1992. In addition, on December 6, 1991, this case was consolidated with an earlier declaratory relief suit filed by CLBN against Century. The Company was not a party to this earlier suit. On February 3, 1993, the court dismissed with prejudice Century's complaint against the Company and all of the other defen- dants, for failure to comply with discovery orders. On July 14, 1993, Century moved to vacate the judgment in the Company's and other defendants' favor, which motion was denied. Century has filed a notice of appeal of denial of its motion to vacate. The parties have not completed the appeal briefing and no date has been set for the hearing of the appeal.\nOn January 18, 1991, Andrea Kune, a stockholder of the Company, filed a derivative lawsuit on behalf of the Company against Messrs. Parretti, Fiorini, Globus and Dimbort, Valentina Parretti (Mr. Parretti's daughter), Ms. Cecconi, Antonio Pares-Neira and Lewis P. Horwitz, alleging breach of fiduciary duty, abuse of control, waste of corporate assets, fraud and deceit, negligent misrepresentation and constructive fraud. The Company was named as a nominal defendant only. On September 16, 1991, the Company filed\na Statement of Non-Response asserting that it had no obligation to respond to the complaint because the complaint seeks no relief from the Company. A second amended complaint was filed on July 27, 1992 against the same defendants in which the Company was again named as a nominal defendant. Kune alleges claims for breach of fiduciary duty, fraud and deceit, negligent misrepresentation and constructive fraud against the defendants. The amended complaint seeks unspecified damages. The Company remains a nominal defendant only and no claims for monetary relief are asserted against it.\nOn January 8, 1992, Fabio Serena, a former employee of the Company, filed a lawsuit in Los Angeles Superior Court against the Company. The Complaint contains causes of action for (i) breach of contract; (ii) breach of covenant of good faith and fair dealing; (iii) promissory fraud; (iv) fraud; (v) intentional infliction of emotional distress; and (vi) negligent infliction of emotional distress. Mr. Serena's complaint sought in excess of $6,750,000 in compensatory damages, and $10,000,000 in punitive damages, in addition to costs of suit and interest. All of the plaintiff's claims have been dismissed with the exception of one cause of action for breach of contract which seeks damages \"in excess of $1,000,000,\" together with interest and costs of suit. A confidential settlement was agreed in December 1993, pursuant to which the case was dismissed with prejudice.\nOn January 27, 1992, Linda Carter filed an application for award for employer violation of Section 132(a) of the Labor Code before the Workers' Compensation Appeals Board of the State of California against the Company and MGM seeking reinstatement of employment, back wages at approximately $21,000 per year plus benefits and costs of suit. The application alleges Ms. Carter was laid off on March 4, 1991, in retaliation for filing a workers' compensation claim. The Company is vigorously defending this action.\nOn January 21, 1992, CLBN filed an action in the Delaware Chancery Court in which CLBN asserted various claims against the Company, Gestione Nuove Attivita Finanziarie S.a.r.l. (a company controlled by Ms. Cecconi) (\"GENAF\"), Melia and certain subsidiaries of Melia seeking, among other things, a judicial declaration that: (i) a purported transfer of common stock of the Company from Melia and certain of its subsidiaries to GENAF (the \"Subject Stock\") is null, void and without effect; and (ii) the Company should issue new stock certificates to CLBN representing the Subject Stock or impose a constructive trust on the Subject Stock held by GENAF. On February 4, 1992, the Delaware Chancery Court issued an order sequestering the Subject Stock. The Company, Melia and its subsidiaries have answered the complaint. In addition, Melia has filed a third-party complaint seeking damages and injunctive and declaratory relief against GENAF, Mr. Parretti and Ms. Cecconi alleging, among other things, fraud and conversion. On or about February 6, 1992, Mr. Parretti and GENAF applied to the Civil Court in Rome for the appointment of a custodian of issued shares in the Company and MGM purportedly held by Mr. Parretti and GENAF and for precautionary measures to protect the assets of the Company and MGM against further alleged diminution in value being caused by CLBN. The Court on or about February 24 and March 6, 1992 issued temporary ex parte orders decreeing that the shares of the Company and MGM are validly within the custody of the Court, and appointing Paolo Picozza as custodian of the shares in dispute. With consent of the court on March 6, 1992, Mr. Picozza purported to take action to amend Pathe's By-Laws to increase the number of directors of the Company to thirty and to appoint eight additional directors of the Company. Mr. Picozza also purported to take action to remove the current directors of MGM and to replace them with seven new directors. On March 12, 1992, CLBN filed a special appearance with the Court objecting to the decrees on the grounds, among other things, that the stock certificates presented to the Court as evidence of Mr. Parretti's controlling interest in the Company and MGM were either already sequestered by the Delaware Chancery Court on February 12, 1992, pursuant to an order of that court dated February 4, 1992, or\npreviously certified lost and replaced, as well as on various procedural and jurisdictional grounds. A hearing was held on Friday, March 20, 1992 regarding CLBN's special appearance. On March 18, 1992, Mr. Parretti and GENAF filed an appeal with the Italian Supreme Court on jurisdictional issues and CLBN filed a counter appeal (no hearing has so far been fixed by the Supreme Court). A new temporary order was rendered on April 28, 1992 confirming the two earlier decisions. The April 28, 1992 order provided for a 180-day time period during which Mr. Parretti and GENAF should bring an action on the merits. On October 18, 1992, Mr. Parretti filed an action for damages against CLBN and the first hearing was scheduled for March 22, 1993. The case is, however, suspended until the Italian Supreme Court has rendered its decision on the jurisdictional issues.\nOn May 6, 1992, Robert Solomon filed a complaint in Delaware Chancery Court against the Company, CLBN, Dennis Stanfill, Alan Ladd, Jr., Charles Meeker, Kenneth Meyer, Jay Kanter, William Jones, Thomas Carson, Rene Claude Jouannet, Bahman Naraghi, Guy Etienne Dufour, G. Goirand and Jacques Bertholier alleging breach of defendants' duties of fair dealing and breach of fiduciary duties to the public stockholders of the Company in connection with the foreclosure and CLBN's Tender Offer for the Company's stock at a price of $1.50 per share. Plaintiff filed the action on his own behalf and as a class action on behalf of a purported class of public stockholders of the Company. On March 15, 1994, Solomon filed an amended class action complaint against the Company, CLBN and certain of the previously named individuals. Although the Company is still studying the amended complaint, no monetary relief is sought against the Company. The Company plans vigorously to defend the action.\nOn December 7, 1992, MGM filed an action against Tracinda, Jeffrey Barbakow, Kirk Kerkorian, Stephen Silbert (the \"Kerkorian Defendants\") and Houlihan, Lokey Howard & Zukin, Inc. (\"HLHZ\") in the Superior Court in Los Angeles. On December 22, 1992, MGM filed an amended complaint which sets forth claims for breach of fiduciary duty, aiding and abetting breach of fiduciary duty, breach of contract and negligence in connection with the sale of MGM to the Company in the fall of 1990. MGM alleges, among other things, that the defendants engaged in a scheme to induce the independent members of MGM's Board to approve the merger to MGM's detriment. MGM seeks damages in an amount of $750,000,000, plus punitive damages according to proof at trial, and a declaration that the indemnity provisions of certain agreements executed in connection with the merger do not cover any judgment, settlement, fees or costs incurred by the Kerkorian Defendants in a legal action. On December 17, 1992, the Kerkorian Defendants filed an answer denying the alle- gations of the complaint and a cross-complaint against MGM for breach of contract, tortious bad faith, breach of indemnification agreements, equitable indemnity and declaratory relief. The cross-complaint seeks damages according to proof at trial, exemplary damages, attorneys' fees and costs. On January 27, 1993, HLHZ filed an answer denying the allegations of the complaint and a cross-complaint against MGM, the Company and CLBN for declaratory relief, fraud, negligent misrepresentation and equitable indemnity. The Company answered HLHZ's cross-complaint on March 29, 1993. HLHZ seeks, among other things, indemnification from the Company under the terms of an engagement letter between HLHZ and the Company and damages for fraud, negligent misrepresentation and equitable indemnity in an amount according to proof at trial, plus attorneys' fees, costs and expenses. Discovery in this action has commenced. On October 13, 1993, a Special Referee in this matter recommended that the Court enter an order declaring that the Company be required to advance to HLHZ its reasonable attorneys' fees in this matter pursuant to the engagement letter, subject to repayment if HLHZ were later found to have committed fraud. The Court did enter such an order, and the Company has moved for reconsideration of that decision. If upheld, such a declaration or order could result in the imposition of substantial liability and other obligations upon the Company, in an amount as yet undetermined but likely to be beyond the Company's present financial\ncapabilities or otherwise materially adverse to the Company. The Court has stated that the matter will come on for trial in June 1994. The Company is vigorously litigating these actions.\nOn April 16, 1993, the Company filed a bankruptcy petition against Melia with the Bankruptcy Chamber of the Amsterdam District Court. This petition was joined by the Dutch tax authorities, Scotti International N.V., Cannon Cinema B.V. and CLBN. At a hearing on April 27, 1993, the Court found that Melia had ceased to pay its debts and declared Melia officially bankrupt. The Court appointed Mr. R.W. De Ruuk as official receiver in the bankruptcy. The appeal period under the governing Dutch Bankruptcy Code has lapsed. Mr. De Ruuk has deposited three public reports with the Dutch authorities. It appears to the Company from such reports that no material recovery benefiting it will be forthcoming.\nOn June 29, 1993, Aurelio Germes, a former officer of the Company, filed a declaratory relief action against the Company. Mr. Germes seeks a declaratory judgment that the Company is obligated to pay Mr. Germes' legal fees in connection with the SEC investigation and in defense of the Kune matter. The Company filed an answer to this complaint on August 12, 1993. The Company intends to vigorously defend this action. Trial of the action is set for May 24, 1994.\nDemands for the advancement of legal fees and indemnification in the defense of the Kune and Williams actions have been made by Giancarlo Parretti, Maria Cecconi and Valentina Parretti (collectively, the \"Parrettis\"). In addition, a demand for the advancement of legal fees for defense of the Kune case has been made by Yoram Globus. The Company has rejected these demands. A claim has also been made by the Parrettis' former attorneys in those cases for fees already incurred, in amounts totaling less than $100,000, and the Company is investigating this matter to determine what, if any, liabilities it may have in respect of this claim. In addition, there have been additional claims for indemnification and/or the advancement of expenses and legal fees which have been asserted from time to time by former officers, directors and/or employees of the Company, and the Company reviews each demand on a case-by- case basis.\nNOTE 10 - SUPPLEMENTARY CASH FLOW INFORMATION\nTotal interest paid was $3,770,000, $6,481,000 and $6,478,000 for fiscal years ended December 31, 1993, 1992 and 1991, respectively. Income taxes paid were $66,000 in fiscal year 1991.\nFiscal Year Ended December 31, 1992\nOn May 7, 1992, approximately $140,000,000 of indebtedness under the credit facilities was relieved in the Foreclosure (see Note 3).\nFiscal Year Ended December 31, 1991\nIn the year ended December 31, 1991, Comfinance and Interpart paid certain Company expenses in the amount of $8,892,000, which payments were offset against certain receivables due from the Company.\nThe Company repaid $50,000,000 of debt by offsetting amounts owed to it by Comfinance with amounts due to other European Interests.\nThe Company repaid indebtedness to CLBN of $150,000,000 upon CLBN's assumption of a $150,000,000 receivable the Company had from Melia.\nNOTE 11 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nSelected financial information for the quarterly periods for the fiscal years ended 1993 and 1992 are presented below (in thousands, except per share amounts):\nDuring 1993, the Company, CLBN, MGM and various other parties settled certain litigation matters. The Company's share of these costs was $3,830,000 and was accrued by the Company during the fourth quarter of 1993. In addition, the Company accrued $4,000,000 during the fourth quarter of 1993 as additional legal reserves in connection with pending litigation (see Note 9).\n1992 Quarterly Results.\nIn May 1992, CLBN foreclosed on the common stock of MGM (see Note 3). The Company recorded a loss provision on its investment during the first quarter of 1992.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nFredric S. Newman, age 48, has been the sole director and sole executive officer of the Company since May 6, 1993, when he was elected President, Secretary and Treasurer of the Company. He has been a practicing attorney in New York City for more than the past five years. In 1991 he was the Chief Executive Officer of World Team Tennis, Inc., and prior thereto he was Vice President and General Counsel of Philip Morris Incorporated.\nPursuant to an agreement dated as of May 1, 1993 between the Company and Mr. Newman, Mr. Newman is to serve as President, Secretary and Treasurer of the Company with all of the power and authority to direct and manage the affairs of the Company. The agreement calls for an annual compensation of $75,000 plus certain additional compensation determined on an hourly basis dependent upon the services performed. The term of the agreement is one year, renewable annually, and the Company may terminate the agreement at any time upon payment of the agreed compensation.\nMr. Newman's election to the Board of Directors of the Company was pursuant to CLBN's right to vote the common stock of the Company under the PCC Voting Trusts (see Item 1 \"Changes in Control - Extraordinary Events\").\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nExcept pursuant to the agreement referred to in Item 10, no compensation was awarded to, earned by or paid to Mr. Newman or to any other executive officer or director of the Company for the 1993 fiscal year and no compensation was awarded to, earned by or paid to any person serving as Chief Executive Officer during 1993 for the 1991 or 1992 fiscal years. Mr. Newman earned $81,590 for his services to the Company during 1993.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth, as of March 18, 1994, certain information concerning ownership of shares of common stock (the only outstanding class of capital stock to the Company) by (i) each person who is known by the Company to own beneficially more than five percent of its issued and outstanding common stock, (ii) each current Director and (iii) all current officers and Directors of the Company as a group. This information is based on information provided to the Company by or on behalf of the stock-\nholder or on the most recently available public information filed by or on behalf of the stockholder.\n(1) Based on 116,746,810 shares of Common Stock issued and outstanding. This figure includes 49,000,000 shares of Common Stock issued to Melia and 8,000,000 shares of Common Stock issued to Comfinance pursuant to subscription agreements dated November 1, 1990, between the Company and each of Melia and Comfinance. Except as indicated below, each of the persons or entities listed above has sole voting and investment power with respect to all share shown for such person or entity.\n(2) CLBN owns 2,798,424 shares of the Company's common stock, purchased pursuant to a tender offer completed June 5, 1992, as more fully described under the caption Certain Relationships and Related Transactions. CLBN exercises voting power over 110,348,460 shares pursuant to certain voting trusts and pledge agreements. The shares of stock held by Melia, Renta Inmobiliaria International B.V. (\"Renta B.V.\") and Renta Corp. as well as the 57,000,000 shares issued to Melia and Comfinance pursuant to their subscription agreements with the Com- pany are, as more fully described under the caption \"Certain Relationships and Related Transactions--Changes in Corporate Control,\" pledged to CLBN, subject to a prior pledge by Melia of the shares owned by it to Sealion (see Note 4 of the Notes to the Company's Consolidated Financial Statements -- Bank Note Payable), to secure all obligations of Melia, the Company, MGM and its direct and indirect subsidiaries and affiliates to CLBN, as well as all existing indebtedness of Melia to CLBN, indebtedness and obligations under all other agreements between the Company and CLBN entered into prior to those agreements and under agreements between MGM and CLBN, whether entered into at the time of such agreements or prior thereto pursuant to which there is an existing indebtedness or obligation to CLBN, and under all agreements entered into in connection with, or referred to, in any of those agreements.\n(3) Mr. Parretti and his wife, Mrs. Cecconi, are the majority owners of Comfinance. (Mr. Parretti holds 14% and Mrs. Cecconi holds 57%.) According to Mr. Parretti, he and Mrs. Cecconi hold their respective shares under a separate property agreement governed by the laws of Italy. They do not share any voting or dispositive power over their respective shares in Comfinance. Interpart S.A. (\"Interpart\") is beneficially owned by Mr. Parretti and certain of his affiliates. Interpart is currently in voluntary liquidation and its management is conducted by a liquidator. The shares indicated as being beneficially owned by Comfinance and Interpart include approximately 31,000,000 shares (approximately 51.7% of the outstanding shares) held by Melia, 16,551,724 shares (approximately 27.7% of the outstanding shares) held by Renta B.V., 5,812,000 shares (approximately 9.7% of the outstanding shares) held by Renta Corp., and 407,990 shares (approximately .7% of the outstanding shares) held by Viajes Melia (\"Viajes\").\nComfinance and Interpart together own 48.7% of the outstanding ordinary and preferred stock of Melia (Comfinance holds 24.4% and Interpart holds 24.3.%). SASEA Holding S.A. (anciennement Societe Anonyme Suisse d'Exploitations Agricoles \"SASEA\") and certain of its affiliates own 50.3% of the outstanding ordinary and preferred stock of Melia (SASEA directly holds 20%). There is currently a dispute in a Swiss court between SASEA and Interpart regarding the ownership of 2.4% of the shares of Melia currently held by SASEA. The outcome of this action will determine the control of Melia. Florio Fiorini, formerly a Director of the Company, was previously a member of the Executive Committee of SASEA, and is purportedly the owner of a significant minority interest in the outstanding stock of SASEA. In October 1992, SASEA was declared bankrupt under Swiss law. The competent court in Geneva, Switzerland appointed special administrators to liquidate SASEA's assets. Management control of Melia is vested in its Board of Managing Directors, which currently consists solely of members appointed by SASEA. A foundation controlled by Mr. Parretti, Mr. Fiorini and Mr.\nParretti's daughter, Valentina Parretti, exercises rights with respect to Melia including the approval of certain actions of the Board of Managing Directors and certain rights with respect to the appointment of the Board of Managing Directors. Melia is the controlling stockholder of Viajes through Corporacion Viajes Melia S.A. Melia is the sole stockholder of Renta B.V. which in turn is the sole stockholder of Renta Corp.\n(4) Includes the 16,551,724 shares owned by Renta B.V. and the 5,812,000 shares owned by Renta Corp. The Company is reviewing the facts and circumstances surrounding the issuance of the 16,551,724 shares owned by Renta B.V. to determine whether such shares were validly issued, including the issue of whether sufficient consideration was received by the Company for the issuance of such shares.\nITEM 13.\nITEM 13. CERTAIN RELATIONS AND RELATED TRANSACTIONS.\nFor additional information concerning certain transactions with prior management and other related parties, see Notes 4, 6, 8, 9 and 10, of the Notes to the Company's Consolidated Financial statements.\nChanges in Corporate Control\nSince June 1991, the Company has experienced changes in corporate control. As a result of these changes, the sole member of the Board of Directors and the sole officer of the Company is a person designated by CLBN, the Company's principal creditor, in its capacity as voting trustee and pledgee of the Company's common stock (see Item 1 \"Business--Changes in Corporate Control, Extraordinary Events\" and Item 3 \"Legal Proceedings\").\nCLBN\nThe Company is currently dependent on CLBN for additional capital to fund its on-going operations. (See Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\".) The Company is in default on its existing indebtedness to CLBN. (See Note 4 of the Notes to the Company's Consolidated Financial Statements.)\nLegal proceedings in which an officer, director, affiliate or owner of more than five percent of the outstanding voting securities of the company has a material interest adverse to the Company.\nFor information concerning legal proceedings in which an officer, director, affiliate or owner of more than 5% of the outstanding voting securities of the Company has a material interest adverse to the Company, see Item 3 Legal Proceedings.\nPART IV\nITEM14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a)(1) and (2) Financial Statements and Schedules\nThe financial statements and schedules listed in the accompanying Index to Financial Statements and Financial Statement Schedules at Page 23 herein are filed as part of this Form 10-K.\n(a)(3) Exhibits:\nThe exhibits listed in the accompanying Exhibit Index are filed as part of this report.\n(b) Reports on Form 8-K:\nDuring the three months ended December 31, 1993, no reports on Form 8-K were filed by the Company.\n(c) Other Exhibits: Exhibit 11 is attached hereto\n(d) Other Financial Statement Schedules: None SIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nPATHE COMMUNICATIONS CORPORATION\nBy /s/Fredric S. Newman Fredric S. Newman President\nDated: March 25, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report had been signed below by the following persons on behalf of the Registrant and in the capacities and on the dated indicated.\nINDEX TO EXHIBITS\nExhibit Number Description\n3.1 Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended January 3, 1987).\n3.2 Amendment dated March 17, 1989 to the Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 1989).\n3.3 By-Laws of the Company as amended through May 6, 1993 (incorporated by reference to Exhibit 3 to the Company's Form 10-Q for the quarterly period ending June 30, 1993).\n3.4 Amendment dated November 8, 1989 to the Restated Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 1989).\n3.5 Resolutions Adopted by the Board of Directors of Pathe Communications Corporation on April 16, 1991 (incorporated by reference to Exhibit 3.5 to the Company's Form 10-K for the year ended December 29, 1990).\n3.6 Resolutions adopted by the Board of Directors of MGM-Pathe Communications Co. on April 16, 1991 (incorporated by reference to Exhibit 3 (3) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n4.1 Indenture, dated as of November 1, 1984, between the Company and Bankers Trust Company, as Trustee, in regard to $70,000,000 12-3/8% Senior Subordinated Notes due 1994 (incorporated by reference to Exhibit 4.1 to the Company's Form S-1 Registration Statement No. 2-93526 filed September 28, 1984).\n4.2 Indenture, dated as of April 15, 1986, between the Company and Manufacturers Hanover Trust Company of California, as Trustee, in regard to $80,500,000 8-7/8% Convertible Senior Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4.1 to the Company's Form S-1 Registration Statement No. 33-3334 filed February 14, 1986).\n4.3 Indenture, dated as of April 15, 1986, between the Company and Manufacturers Hanover Trust Company of California, as Trustee, in regard to $26,500,000 12-7/8% Senior Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4.1 to the Company's Form S-1 Regis- tration Statement No. 33-3333 filed February 14, 1986).\n4.4 Warrant Agreement, dated as of October 15, 1987 between the Company and Warner Communications, Inc. (Incorporated by reference to Exhibit 1 to the Company's Report on Form 8-K filed on October 21, 1987).\n9.1 Voting Trust Agreement by and between the Company and Credit Lyonnais Bank Nederland N.V. dated April 15, 1991 (incorporated by reference to Exhibit 10(9) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n9.2 Voting Trust Agreement by and between the Company and Credit Lyonnais Bank Nederland N.V. dated April 15, 1991 (incorporated by reference to Exhibit 10(10) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.1 Agreement, dated as of May 18, 1989, between the Company, Renta Inmobiliaria, Renta International B.V. and Renta Corp. (incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989).\n10.2 Agreements between certain G&G Interests and the Company, dated as of July 1, 1983 (incorporated by reference to Exhibit A to the Company's Form S-1 Registration Statement No. 2-86297 filed August 30, 1983).\n10.3 Agreement dated as of May 1, 1993 by and between the Company and Fredric S. Newman.\n10.4 Loan out Agreement, dated March 1, 1989, between Pathe Entertainment, Inc. and Kanter Corp. for the services of Jay Kanter (incorporated by reference to Exhibit 10.49 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989).\n10.5 Property and Share Sale Agreement, dated December 29, 1989 by and among Cannon SE Cinema Properties Limited, Cannon Cinemas Limited, Pathe Group (U.K.) Limited and Cinema 5 Europe N.V. (incorporated by reference to Exhibit 10.52 to the Company's Form 10-K for the year ended December 30, 1989).\n10.6 Heads of Agreement, dated December 29, 1989, among Cannon Tuschinski Theaters B.V., Cannon Tuschinski Beheer B.V., Cannon Cinema B.V., Holland Exhibitors B.V., Theaterbedrijf Cinerama Exhibitors Nederland B.V., Nationale Bioscoop Ondernemingen B.V., Cinerama Amsterdam B.V., Cannon Theaters (Nederlands) N.V. and Exploitati- emaatschappij \"Midden- Hofstad\" B.V. (incorporated by reference to Exhibit 10.53 to the Company's Annual Report on Form 10-K for the year ended December 30, 1989).\n10.7 Agreement and Plan of Merger, dated as of June 28, 1990, by and between the Company, MGM/UA Communications Co., and Tracinda Corporation (incorporated by reference to Appendix A to MGM/UA Communications Co. Proxy Statement dated August 31, 1990).\n10.8 Stock Purchase Agreement, dated as of October 26, 1990, between the Company and MGM-Pathe Communications Co. (incorporated by reference to Exhibit B to MGM-Pathe Communications Co. Form 8-K dated November 14, 1990).\n10.9 Agreement, dated March 26, 1990, among Cineplex Odeon, Cannon Cinemas Limited and Cannon SE Cinema Properties Limited (incorporated by reference to Exhibit 10.14 to the Company's Form 10-K for the year ended December 29, 1990).\n10.10 Agreement, dated November 6, 1990, between the Company and Fin Soft Holding S.A. (incorporated by reference to Exhibit 10.15 to the Company's Form 10-K for the year ended December 29, 1990).\n10.11 Subscription Agreement, dated November 1, 1990, between the Company and Melia International N.V. (incorporated by reference to Exhibit 10.16 to the Company's Form 10-K for the year ended December 29, 1990).\n10.12 Subscription Agreement, dated November 1, 1990, between the Company and Comfinance S.A. (incorporated by reference to Exhibit 10.17 to the Company's Form 10-K for the year ended December 29, 1990).\n10.13 Promissory Note, dated November 15, 1990, from Transmarine Holdings S.A. payable to the Company (incorporated by reference to Exhibit 10.18 to the Company's Form 10-K for the year ended December 29, 1990).\n10.14 Comfinance Promissory Note dated November 18, 1990 (incorporated by reference to Exhibit 10.19 to the Company's Form 10-K for the year ended December 29, 1990).\n10.15 Interim Revolving Credit Facility Agreement and Security Assignment, dated March 22, 1991, by and among MGM-Pathe Communications Co. and certain affiliates and Credit Lyonnais Bank Nederland N.V.(incorporated by reference to Exhibit 10.20 to the Company's Form 10-K for the year ended December 29, 1990).\n10.16 Letter Agreement among Credit Lyonnais Bank Nederland N.V., Pathe Communications Corporation, MGM-Pathe Communications Co. and Melia International N.V., dated April 12, 1991 (incorporated by reference to Exhibit 10(5) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.17 Memorandum of Facility Agreement among MGM-Pathe Communications Co. and its U.S. subsidiaries and Credit Lyonnais Bank Nederland N.V., dated April 12, 1991 (incorporated by reference to Exhibit 10(6) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.18 Stock Sale Agreement among Melia International N.V., the Company and CLINVEST, dated April 13, 1991 (incorporated by reference to Exhibit 10(7) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.19 Mandat Exclusif de Vente de Titres among the Company, Melia International N.V. and Credit Lyonnais Bank Nederland N.V., dated as of May 10, 1991.\n10.20 Assignment, Assumption and Release Agreement among Pathe Communications Corporation, Melia International N.V. and Credit Lyonnais Bank Nederland N.V., dated as of April 15, 1991 (incorporated by reference to Exhibit 10(8) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.21 Agreement regarding Certain Corporate Governance Matters for MGM-Pathe Communications Co. dated April 15, 1991 among Giancarlo Parretti, the Company and MGM-Pathe Communications Co. (incorporated by reference to Exhibit 10(11) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.22 Agreement regarding Certain Corporate Governance Matters for Pathe Communications Corporation, among Giancarlo Parretti, the Company and the Company's majority stock- holders (incorporated by reference to Exhibit 10(12) to MGM-Pathe Communications Co. Form 8-K dated May 3, 1991).\n10.23 Amended and Restated Credit Agreement between MGM-Pathe Communications Co. and Credit Lyonnais Bank Nederland N.V. dated as of May 15, 1991 (incorporated by reference to Exhibit 10.31 to the Company's Form 10-K for the year ended December 29, 1990).\n10.24 Schedule 14D-1 Tender Offer Statement and Amendment No. 9 to Schedule 13D of Pathe Communications Corporation filed with the Securities and Exchange Commission by Credit Lyonnais Bank Nederland N.V. on May 8, 1992 (incorporated by reference).\n10.25 Schedule 13E-3 Transaction Statement of Pathe Communications Corporation filed with the Securities and Exchange Commission by Credit Lyonnais Bank Nederland N.V. on May 7, 1992 (incorporated by reference).\n11. Computation of Loss Per Common Share."},"word_count":{"kind":"number","value":17996,"string":"17,996"},"character_count":{"kind":"number","value":115331,"string":"115,331"}}},{"rowIdx":294,"cells":{"filename":{"kind":"string","value":"311100_1993.txt"},"id":{"kind":"string","value":"311100_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"311100"},"text":{"kind":"string","value":"Item 1. Business\nIncorporated herein by reference is the information appearing under the heading \"Business of Jefferson Bankshares\" on page 4 of the 1993 Annual Report to Shareholders (\"1993 Annual Report\"). Also incorporated herein by reference is the information on pages 7 through 10 of the 1993 Annual Report as to the distribution of the Corporation's assets, liabilities and shareholders' equity; pages 15 and 16 of the 1993 Annual Report as to the Corporation's investment portfolio; pages 12 through 15 of the 1993 Annual Report as to the Corporation's loan loss experience; pages 11 through 15 of the 1993 Annual Report as to the Corporation's loan portfolio; pages 16 and 17 of the 1993 Annual Report as to the Corporation's deposits; page 19 of the 1993 Annual Report as to the Corporation's return on equity and assets; and page 17 of the 1993 Annual Report as to the Corporation's short-term borrowings.\nItem 2.\n\n\nItem 2. Properties\nIncorporated herein by reference is the information appearing under the heading \"Business of Jefferson Bankshares\" on page 4 of the 1993 Annual Report and the discussion of premises and equipment in Note 7 (entitled \"Premises and Equipment\") to the financial statements in the 1993 Annual Report.\nItem 3.\nItem 3. Legal Proceedings\nThere are no legal proceedings against the Corporation that would have a material adverse effect on the Corporation or its financial condition.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers of Jefferson Bankshares\n\tThe executive officers of the Corporation are set forth below. All officers are elected annually and, except for Hovey S. Dabney who had an employment contract extending until January 1, 1994, serve at the discretion of the Board of Directors. Except as otherwise noted below, each of the executive officers has worked with the Corporation or its affiliates for at least five years.\nHovey S. Dabney, 70, is Chairman of the Board of Directors and, until January 1, 1994, was also Chief Executive Officer.\nO. Kenton McCartney, 50, is President and Chief Executive Officer. Prior to January 1, 1994, Mr. McCartney was President and Chief Operating Officer.\nRobert H. Campbell, Jr., 59, is Senior Vice President and Treasurer.\nAllen T. Nelson, Jr., 44, is Senior Vice President and Chief Financial Officer. Mr. Nelson joined the Corporation on December 6, 1993. Prior to that date, Mr. Nelson was Senior Vice President and Controller of Dominion Bankshares, Inc. from February, 1992 until joining the Corporation. Prior to February, 1992 he served as Finance Executive Officer with C&S/Sovran Corporation.\nWalter A. Pace, Jr., 61, is Senior Vice President.\nDonald W. Fulton, Jr., 47, is Vice President-Investor Relations.\nWilliam M. Watson, Jr., 39, is Vice President and Secretary. Mr. Watson joined the Corporation on May 13, 1991. Prior to that date, he was an attorney with McGuire, Woods, Battle & Boothe.\nPart II\nItem 5.\nItem 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nIncorporated herein by reference is the information on page 18 under the heading \"Capital Resources\" and in the table captioned \"Common Stock Performance and Dividends\" on page 19 of the 1993 Annual Report.\nIncorporated herein by reference is the discussion of restrictions on the payment of cash dividends in Note 8 (entitled \"Long Term Debt\") to the financial statements in the 1993 Annual Report.\nItem 6.\nItem 6. Selected Financial Data Incorporation herein by reference in the information in the table captioned \"Selected Financial Data\" on page 5 of the 1993 Annual report.\nItem 7.\nItem 7. Management's Discussion and Analysis and Results of Operations and Financial Condition\nIncorporated herein by reference is the information appearing under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 5 through 20 of the 1993 Annual Report, except for the information in the tables captioned \"Selected Financial Data,\" \"Summary of Financial Results by Quarter,\" and \"Common Stock Performance and Dividends\" on pages 5, 6 and 19, respectively, of the 1993 Annual Report.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data\nIncorporated herein by reference is the information appearing under the heading \"Independent Auditors' Report,\" Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Changes in Shareholders' Equity,\" \"Consolidated Statements of Cash Flows\" and \"Notes to Consolidated Financial Statements,\" on pages 21 through 34 of the 1993 Annual Report.\nIncorporated by reference is the information in the table captioned \"Summary of Financial Results by Quarter\" on page 6 of the 1993 Annual Report.\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone\nPart III\nItem 10.\n\n\nItem 10. Directors and Executive Officers of Registrant\nThe information concerning the Corporation's directors is incorporated by reference to the section entitled \"Nominations for Directors\" on pages 4 through 6 of the Corporation's definitive Proxy Statement for the 1994 Annual Meeting of Shareholders.\nThe information concerning the Corporation's executive officers is incorporated by reference to Part I hereof entitled \"Executive Officers of Jefferson Bankshares.\"\nItem 11.\nItem 11. Executive Compensation\nThe information required by this item is incorporated by reference to the sections entitled \"Compensation of Executive Officers and Directors\" on pages 6 through 15 of the Corporation's definitive Proxy Statement for the 1994 Annual Meeting of Shareholders.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item is incorporated by reference to the sections entitled \"Principal Beneficial Owners\" and \"Shares Beneficially Owned by Directors and Executive Officers\" on pages 2 and 3 of the Corporation's definitive Proxy Statement for the 1994 Annual Meeting of Shareholders.\nItem 13.\nItem 13. Certain Relationships\nThe information required by this item is incorporated by reference to the section entitled \"Loans to Officers and Directors\" on page 15 of the corporation's definitive Proxy Statement for the 1994 Annual Meeting of Shareholders.\nPart IV\nItem 14.\nItem 14. Exhibits, Financial Statements and Reports on Form 8-K\n(a) The following documents are filed as part of this report:\n1. Financial Statements. The following Consolidated Financial Statements of Jefferson Bankshares, Inc. and subsidiaries and the Independent Auditors' Report are incorporated by reference to pages 21 through 34 of the 1993 Annual Report:\nIndependent Auditors' Report.\nConsolidated Balance Sheets at December 31, 1993 and December 31, 1992.\nConsolidated Statements of Income for the years ended December 31, 1993, December 31, 1992 and December 31, 1991.\nConsolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1993, December 31, 1992, and December 31, 1991.\nConsolidated Statements of Cash Flows for the years ended December 31, 1993, December 31, 1992 and December 31, 1991.\nNotes to Consolidated Financial Statements.\n2. Exhibits. The exhibits listed on the accompanying Index to Exhibits immediately following the signature page are filed as part of, or incorporated by reference into, this report.\n(b) Reports on Form 8-K\nThe Corporation did not file any reports on Form 8-K for the last fiscal quarter covered by this report.\nExcept for the information referred to in Items 1, 2, 5, 6, 7, 8 and 14(a)(1) hereof, the 1993 Annual Report will not be deemed to be filed pursuant to the Securities Exchange Act of 1934.\nSIGNATURES\nPursuant to the requirements of Section 13 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.\nDATE: March 10, 1994 JEFFERSON BANKSHARES, INC.\nBy: O. Kenton McCartney President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDATE SIGNATURE CAPACITY ---- --------- -------- March 10, 1994 O. Kenton McCartney President, Chief Executive Officer and Director\nMarch 10, 1994 Allen T. Nelson, Jr. Senior Vice President and Chief Financial Officer\nMarch 10, 1994 Hovey S. Dabney Chairman of the Board\nMarch 10, 1994 John T. Casteen, III* Director March 10, 1994 Hunter Faulconer* Director March 10, 1994 Lawrence S. Eagleburger* Director March 10, 1994 Fred L. Glaize, III* Director March 10, 1994 Henry H. Harrell* Director March 10, 1994 Alex J. Kay, Jr.* Director March 10, 1994 J. A. Kessler, Jr.* Director March 10, 1994 W. A. Rinehart, III* Director March 10, 1994 Gilbert M Rosenthal* Director March 10, 1994 Alson H. Smith, Jr.* Director March 10, 1994 Lee C. Tait* Director March 10, 1994 H. A. Williamson, Jr.* Director\n*By: William M. Watson, Jr. Attorney-in-Fact\nEXHIBIT INDEX\nExhibit No. Exhibit\n3. Articles of Incorporation and Bylaws:\n(a) Articles of Incorporation incorporated by reference to Jefferson Bankshares' Annual Report on Form 10-K for 1984.\n(b) Articles of Amendment to Articles of Incorporation dated May 7, 1987, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended June 30, 1987.\n(c) Articles of Amendment to Articles of Incorporation dated March 23, 1993, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended June 30, 1993.\n(d) Amended and Restated Bylaws incorporated by reference to Jefferson Bankshares' Annual Report on Form 10-K for 1991.\n4. Instruments defining the rights of security holders including indentures:\n(a) Articles of Incorporation of Jefferson Bankshares', incorporated by reference to Jefferson Bankshares' 1984 Annual Report on Form 10-K.\n(b) Articles of Amendment to Articles of Incorporation dated May 7, 1987, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended June 30, 1987.\n(c) Articles of Amendment to Articles of Incorporation dated March 23, 1993, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended June 30, 1993.\n(d) Term Loan Agreement dated as of February 1, 1984, between Jefferson Bankshares and Wachovia Bank and Trust Company, N.A., incorporated by reference to Jefferson Bankshares' quarterly report on Form 10-Q for the quarter ended March 31, 1984.\n(e) Amendments dated September 8, 1988 and September 21, 1989, to the Term Loan Agreement between Jefferson Bankshares and Wachovia Bank and Trust Company, N.A., incorporated by reference to Jefferson Bankshares' quarterly report on Form 10-Q for the quarter ended March 31, 1991.\n(f) Amendment dated December 20, 1990, to the Term Loan Agreement between Jefferson Bankshares and Wachovia Bank and Trust Company, N.A., incorporated by reference to Jefferson Bankshares' Annual Report on Form 10-K for 1990.\n10. Material Contracts:\n(a) Senior Officers Supplemental Pension Plan, incorporated by reference to Jefferson Bankshares' 1982 Annual Report on Form 10-K.\n(b) Amended and Restated Employment Agreement dated August 26, 1987, with Hovey S. Dabney, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended September 30, 1987.\n(c) Amendment dated September 26, 1989 to the Amendment and Restated Employment Agreement with Hovey S. Dabney, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended September 30, 1989.\n(d) Amendment dated September 26, 1990 to the Amended and Restated Employment Agreement with Hovey S. Dabney, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended September 30, 1990.\n(e) Deferred Compensation Agreement dated December 18, 1979 with Hovey S. Dabney, incorporated by reference to Jefferson Bankshares' 1984 Annual Report on Form 10-K.\n(f) Amendment dated September 26, 1989 to the Deferred Compensation Agreement with Hovey S. Dabney, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended September 30, 1989.\n(g) Incentive Stock Plan, incorporated by reference to Jefferson Bankshares' report on Form 10-Q for the quarter ended June 30, 1985.\n(h) Amendment dated April 28, 1992 to the Incentive Stock Plan, incorporated by reference to Exhibit 10(f) to Form S-4 of Jefferson Bankshares, Inc., File No. 33-47929.\n(i) Amended and Restated Deferred Compensation Plan for Directors, incorporated by reference to Jefferson Bankshares' Annual Report on Form 10-K for 1985.\n(j) Split Dollar Life Insurance Plan, incorporated by reference to Jefferson Bankshares' Annual Report on Form 10-K for 1984.\n*(k) Executive Severance Agreement dated October 25, A 1993 between Jefferson Bankshares and O. Kenton McCartney is filed herewith.\n*(l) Executive Severance Agreement dated October 25, B 1993 between Jefferson Bankshares and Robert H. Campbell, Jr. is filed herewith.\n*(m) Amended and Restated Split Dollar Life Insurance C Agreement dated October 29, 1993 between Jefferson Bankshares and Hovey S. Dabney is filed herewith.\n*(n) Amended and Restated Split Dollar Life Insurance D Agreement dated October 29, 1993 between Jefferson Bankshares and Robert H. Campbell, Jr. is filed herewith.\n*(o) Amended and Restated Split Dollar Life Insurance E Agreement dated October 29, 1993 between Jefferson Bankshares and O. Kenton McCartney filed herewith.\n13. Annual Report to Security Holders, Form 10-Q or F Quarterly Report to Security Holders\n21. Subsidiaries of the Registrant G\n23. Consents of Experts and Counsel H\nConsent of KPMG Peat Marwick to incorporation by reference of auditors' reports into Jefferson Bankshare's Registration Statement Form S-3 is filed herewith.\n24. Powers of Attorney I\n* Management contract or compensatory plan or arrangement of the Corporation required to be filed as an exhibit."},"word_count":{"kind":"number","value":2175,"string":"2,175"},"character_count":{"kind":"number","value":14069,"string":"14,069"}}},{"rowIdx":295,"cells":{"filename":{"kind":"string","value":"39677_1993.txt"},"id":{"kind":"string","value":"39677_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"39677"},"text":{"kind":"string","value":"Item 1. Business\nAvatar Holdings Inc. (a Delaware corporation incorporated in 1970) and its subsidiaries (collectively, \"Avatar\" or the \"Company\") are engaged in two principal business activities: real estate and water and wastewater utilities operations. Avatar's real estate operations, which are located in the states of Florida, Arizona and California, include the development and sale of homesites; the development and sale of improved and unimproved homesites and commercial/industrial land tracts; the construction and sale of single family and multifamily housing; operations of amenities and resorts; development, sale and management of vacation ownership units in Avatar's Poinciana community; cable television operations and property management services. Avatar provides financing for a large portion of its homesite sales, mainly under a deed and mortgage arrangement. Avatar's utility operations consist of water and wastewater treatment plants which serve communities in Florida and Arizona. During 1993, approximately 56% and 44% of the total revenues were generated through real estate and utility operations, respectively, net of the gain on the sale of the midwest water utilities discussed below.\nOn August 31, 1993, the Company sold its water and wastewater utilities located in Indiana, Missouri, Ohio, and Michigan (the \"Midwest Water Utilities\") for an aggregate selling price of $62,000,000, resulting in a pre-tax gain of $21,822,000.\nIn the current year the Company has invested approximately $51,000,000 cash in an investment trading portfolio. (See Liquidity section)\nAvatar's revised business strategy includes a shift away from homesite sales and toward housing, retail and industrial real estate development, sales of vacation ownership intervals and resort operations. Certain of Avatar's properties are being developed and such developments are at different stages of completion. In addition, Avatar is examining each of its remaining principal properties in an effort to determine the best long-term use or development.\nInformation regarding revenues, results of operations and assets of the two business segments noted above are included in Item 8 under the caption \"Notes to Consolidated Financial Statements\".\nReal Estate\nAvatar's assets include real estate inventory in the states of Florida, Arizona and California. In its Florida communities of Poinciana, Barefoot Bay, Cape Coral, Golden Gate and Leisure Lakes, as well as in its Arizona community of Rio Rico, Avatar's activities include homesite and industrial/commercial land sales, the construction and sale of single family and multifamily housing, and the construction, sale and management of vacation ownership units, with the types of activities varying from community to community. Avatar owns other sites including Harbor Islands in Hollywood, Florida; Banyan Bay in Martin County, Florida; Ocala Springs in Marion County, Florida; and Woodland Hills in Los Angeles County, California.\nPoinciana, located in central Florida approximately 21 miles south of Orlando and 10 miles from Walt Disney World, encompasses 47,000 acres of land, approximately 15,500 of which are owned by Avatar. This planned community development includes subdivisions for single family, multifamily and manufactured housing, and commercial/industrial areas. Since 1971, 21,860 homesites have been sold and approximately 4,219 housing units, primarily single family houses and townhouses, have been\nItem 1. Business -- Continued\nconstructed by Avatar and other non-affiliated builders. As of December 31, 1993, approximately 12,965 developed and undeveloped homesites remained in inventory at Poinciana. Additionally, approximately 4,456 acres of land zoned for industrial/commercial and multifamily use also remained in inventory. At December 31, 1993, Avatar had firm contracts at Poinciana to construct 49 single family units with a total sales volume of $3,726,488. Avatar's real estate activities at Poinciana also include the construction, sale and management of vacation ownership units. As of December 31, 1993, 1,606 unit weeks had been sold and 1,306 unit weeks remained in inventory at Poinciana. Avatar also owns and operates a 31,100 square foot shopping center at Poinciana that was 100% occupied at December 31, 1993. Recreational facilities owned and operated by Avatar at the Poinciana development include an 18-hole Devlin Von-Hagge championship golf course, tennis courts, a golf and racquet club with a swimming pool, a community center and a series of nature walks and trails.\nBarefoot Bay is located on Florida's east coast, midway between Vero Beach and Melbourne. Avatar's operations at Barefoot Bay include the sale of manufactured homes and homesites. Since operations commenced in 1970, approximately 94% of the 5,020 available homesites have been sold. At December 31, 1993, Avatar had firm contracts to construct 8 housing units at a total selling price of $683,000. Recreational facilities owned and operated at Barefoot Bay by Avatar include an 18-hole executive golf course, a community center, swimming pools, tennis courts, a private beach and a fishing pier. Avatar also owns and operates a 13,420 square foot shopping center in Barefoot Bay that was 100% occupied at December 31, 1993.\nAvatar also owns 268 acres adjacent to Barefoot Bay. Platting, design and engineering for this proposed golf course community of 630 conventional single-family and zero-lot line homesites commenced in 1989 and is continuing through 1994.\nCape Coral is a 60,700-acre community, of which approximately 3,727 acres are owned by Avatar, located on Florida's west coast seven miles west of Fort Myers. Its population has increased from 11,470 in 1970 to approximately 84,000 in 1993. To accommodate this increase, Avatar constructed, during 1991, the Camelot Isles Shopping Center, a 70,000 square foot retail center that opened in February 1992. At December 31, 1993, the shopping center was 89% occupied. Remaining inventory at December 31, 1993, included approximately 3,734 single family homesites and 2,700 acres of land zoned for commercial, industrial and multifamily use. Avatar's Tarpon Point Marina, which is located in Cape Coral, accommodates 175 vessels and features dockmaster facilities, a ship's store and fueling facilities. The Camelot Marina, for which the initial phase of construction was completed in 1991, will accommodate 76 vessels and feature 3,500 feet of boardwalk upon completion. Other amenities available to the residents of Cape Coral include Avatar's Cape Coral Golf and Tennis Resort that features an 18-hole championship golf course, a 9-hole executive golf course, eight tennis courts and a 100- room motel.\nGolden Gate City, located east of Naples in southwest Florida, had remaining inventory as of December 31, 1993 which included 32 single family and duplex homesites, 43 acres of land zoned for multifamily use and 10 acres zoned for commercial use.\nGolden Gate Estates comprises 2,497 acres of land subdivided into 5,800 homesites. Remaining inventory as of December 31, 1993, includes approximately 130 homesites of varying size, the majority of which are approximately 1 and 1-1/4 acre homesites, and 7,400 acres of land held for future use.\nItem 1. Business -- Continued\nAvatar's land holdings in Leisure Lakes, located near the city of Lake Placid in South Central Florida, consist of 3,244 homesites remaining in inventory at December 31, 1993. Amenities at Leisure Lakes include a 9-hole executive golf course, a small lakefront motel, tennis courts, shuffleboard courts, a swimming pool, a club house with pro shop, a coffee shop, a private beach, a boat ramp, a card room and various lakes available for water sports.\nRio Rico, a 55,000-acre community development in southern Arizona, is located 57 miles south of Tucson. This community, with a population of approximately 4,700 residents, consists of single family homes and townhouses and includes several areas zoned for commercial and industrial development. Avatar owns and operates a 175-room hotel complex, an 18-hole Robert Trent Jones designed championship golf course and a 36,800 square foot shopping center, which was 98% occupied as of December 31, 1993. Remaining inventory at Rio Rico at December 31, 1993 included approximately 3,575 single family homesites, 2,536 acres of land zoned for commercial, industrial and multifamily use, 4,762 acres of land held for future development, sale or other use, and 2,838 acres of undeveloped mountain range reserved for open space.\nThe Harbor Islands Project encompasses 191 acres, including 30 acres conveyed to the city of Hollywood for future parks, adjoining the Intra-coastal Waterway in Hollywood, Florida. An approved plan for this water-oriented community provides for 2,700 high-rise condominium units, 447 townhouses and triplex dwelling units, 28 single family homesites, 65,000 square feet of commercial space and a 150-room hotel. Additionally, permits have been obtained and preliminary construction completed on a 196-boat slip marina.\nBanyan Bay, located in Martin County, Florida, comprises 251 acres of land. Future plans contemplate a medium-density residential development of two and four story condominiums.\nOcala Springs, located five miles northeast of Ocala in Marion County, Florida, comprises 4,600 acres of land. The concept plan for this project provides for 700 single family ranchettes on 1-1/4 to 1- 1/2 acre lots, 4,800 single family homesites on 1/4 to 1/2 acre lots, 400 homesites for manufactured housing and 1,000 multifamily condominium units. Also planned are an 18-hole golf course and more than 130 acres for commercial, industrial and service facilities. These plans have been reviewed by all appropriate state, regional and local governmental agencies and the plat for Phase I has been filed with and accepted by Marion County.\nWoodland Hills, located in northwest Los Angeles County, California, consists of the Natoma tract that encompasses approximately 430 acres of land. Conceptual planning for this tract has been completed for 108 luxury homesites. An environmental impact report has been filed and is being reviewed by the City of Los Angeles.\nIn addition to the real estate holdings described above, Avatar owns approximately 2,500 acres of land in Florida that is being held for future development or bulk sales.\nUtilities\nAvatar's water and wastewater treatment facilities include 12 water treatment facilities and 10 wastewater treatment facilities serving 6 communities in Florida (including Poinciana, Barefoot Bay and Golden Gate). These facilities provide for the treatment, distribution and sale of water for public and\nItem 1. Business -- Continued\nprivate use, and the treatment and disposal of wastewater. At December 31, 1993, Avatar's utility operations had approximately 35,000 water customers and 29,000 wastewater customers.\nOn January 30, 1993, the Company entered into stock purchase agreements for the sale of its Midwest Water Utilities. The closing of the sale of the Midwest Water Utilities took place on August 31, 1993, for an aggregate selling price of $62,000,000, resulting in a pre-tax gain of $21,822,000.\nAn Avatar subsidiary provides consulting, data processing and other services to non-affiliated utility companies as well as to various Avatar subsidiaries. This subsidiary is beginning to operate water and wastewater systems under contracts with unaffiliated companies.\nEmployees\nAs of December 31, 1993, Avatar employed approximately 950 individuals on a full-time or part-time basis. In addition, Avatar utilizes on a daily basis such additional personnel as may be required to perform various land development activities. Avatar's relations with its employees are satisfactory and there have been no work stoppages.\nRegulation\nAvatar's real estate operations are regulated by various local, regional, state and federal agencies, including the Federal Trade Commission (FTC). The extent and nature of these regulations include matters such as planning, zoning, design, construction of improvements, environmental considerations and sales activities. For its community developments in Florida and Arizona, state laws and regulations may require the filing of registration statements, copies of promotional materials and numerous supporting documents, and the delivery of an approved disclosure report to purchasers, prior to the execution of a land sales contract. In addition to Florida and Arizona, certain states impose requirements relating to the inspection of properties, approval of sales literature, disclosures to purchasers of specified information, assurances of future improvements, approval of terms of sale and delivery to purchasers of a report describing the property. Federal regulations adopted pursuant to the Interstate Land Sales Full Disclosure Act provide for the filing or certification of a registration statement with the Office of Interstate Land Sales Regulation of the Department of Housing and Urban Development. Avatar's homesite installment sales activities are required to comply with the Federal Consumer Credit Protection (\"Truth-in-Lending\") Act.\nAvatar's utility operations and rate structures are regulated by various federal, state and county agencies and must comply with federal and state treatment standards. All sources of water and wastewater effluent are required to be tested on a regular basis and purified in order to comply with governmental standards.\nThe Company believes it is in compliance with applicable laws and regulations in all material respects.\nCompetition\nAvatar's real estate operations, particularly in the state of Florida, are highly competitive. In its sales of homesites and housing units, Avatar competes, as to price and product, with several land\nItem 1. Business -- Continued\ndevelopment companies for the discretionary income of individuals who desire eventually to relocate or establish a second home in Florida or Arizona. In recent years, there have been extensive land development projects in the geographical areas in which Avatar operates. The vacation ownership sales business is also highly competitive with companies throughout the United States and abroad selling vacation ownership unit weeks on terms similar to those offered by Avatar.\nItem 2.\n\n\nItem 2. Properties\nAvatar's real estate operations are described in Item 1 above. Land in the process of being developed, or held for investment and/or future development, has an aggregate cost of approximately $113,623,000 as of December 31, 1993.\nAvatar's utility operations include water and wastewater plants and equipment located in Florida. Such properties have a net book value of $150,812,206 at December 31, 1993.\nAvatar's corporate headquarters are located at 255 Alhambra Circle, Coral Gables, Florida, in approximately 26,595 square feet of leased office space. For additional information concerning properties leased by Avatar, see Item 8, \"Notes to Consolidated Financial Statements.\"\nItem 3.\nItem 3. Legal Proceedings\nAvatar is involved in various pending litigation matters primarily arising in the normal course of its business. Although the outcome of these and the following matters can not be determined, it is the opinion of management that the resolution of such matters will not have a material effect on Avatar's business or financial position.\nOn October 1, 1993, the United States, on behalf of the U.S. Environmental Protection Agency, filed a civil action against a utility subsidiary of Avatar in the U.S. District Court for the Middle District of Florida. (United States vs. Florida Cities Water Company, Civil Action No. 93-281-C1) The complaint alleges that the subsidiary's wastewater treatment plant in North Fort Myers, Florida, committed various violations of the Clean Water Act, 33 U.S.C. S1251 et seq., including (1) discharge of pollutants without an operating permit from October 1, 1988 to October 31, 1989; (2) discharging from an unpermitted discharge location from November 1, 1989 until July 14, 1992; and (3) discharging pollutants in excess of permit limitations at various times from July 1991 to June of 1992. The government is seeking the statutory maximum civil penalties of $25,000 per day, per violation based upon the allegations. The Subsidiary strongly believes that there are mitigating facts as well as valid legal defenses that could reduce or eliminate the imposition of monetary sanctions.\nOn March 1, 1994, the Wisconsin Department of Natural Resources (the \"Department\") sent Avatar notice that the Department had recently issued a second Record of Decision (\"ROD\") in connection with the Edgerton Sand & Gravel Landfill site (the \"Site\"). The ROD calls for the City of Edgerton's public water supply system to be extended to the owners of private wells in the vicinity of the Site. The ROD also states that other work related to soil and groundwater remedial action would be required at the Site. The Department demanded that all potentially responsible parties (\"PRPs\") associated with the Site organize into a PRP group to undertake the implementation of the ROD. Avatar was previously identified as a PRP by the Department. Avatar believes that it is not liable for any claims by any governmental or private party in connection with the Site.\nItem 3. Legal Proceedings -- Continued\nOn February 25, 1994, Mr. Wilkov commenced a lawsuit against Avatar, Mr. Jacobson and Odyssey Partners, L.P. (\"Odyssey\"), in the Circuit Court of Eleventh Judicial Circuit in and for Dade County Florida, claiming damages arising out of Mr. Wilkov's termination of his employment purportedly for \"Good Reason\" (as defined in his employment agreement). Mr. Wilkov also seeks to recover damages from Avatar for libel and slander and from Odyssey and Mr. Jacobson based on their alleged malicious interference with his employment agreement. Avatar denies that Mr. Wilkov had Good Reason to terminate his employment agreement. Avatar, Odyssey and Mr. Jacobson do not believe there is any valid basis for Mr. Wilkov's claims, and various affirmative defenses have been asserted. Avatar also has asserted counterclaims against Mr. Wilkov for breach of contract, promissory estoppel and improper inducement in connection with amendments to Mr. Wilkov's employment agreement.\nItem 4.\nItem 4. Submission of Matters to a Vote Security Holders\nNone\nExecutive Officers of the Registrant\nPursuant to General Instruction G (3) to Form 10-K, the following list is included as an unnumbered item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on May 26, 1994.\nThe following is a list of names and ages of all of the executive officers of Avatar, indicating all positions and offices with Avatar held by each such person and each such person's principal occupation(s) or employment during the past five years unless otherwise indicated. All such persons have been elected to serve until the next annual election of officers (which is expected to occur on May 26, 1994) when they are reappointed or their successors are elected, or until their earlier resignation or removal.\nName Age Office and Business Experience\nLeon Levy 68 Chairman of the Board since January 1981; General Partner, Odyssey Partners, L.P., a private partnership engaged in investment, trading and related activities; Chairman of the Board of Oppenheimer Funds; former Chairman of the Board (1974-1985) of Oppenheimer Management Corp.; Director of: Electra Investment Trust PLC, Mercury Assets Management, Ltd., and S.G. Warburg & Co., Ltd. (Jersey Funds).\nEdwin Jacobson 64 President and Chief Executive Officer since February 1994; Chairman of the Executive Committee since June 1992; President and Chief Executive Officer of Chicago Milwaukee Corporation since June 1985; President and Chief Executive Officer of CMC Heartland Partners since September 1990, and President and Chief Executive Officer, since June 1985, of Milwaukee Land Company, a non- diversified, closed-end management investment company, publicly traded since July 1993.\nDennis J. Getman 49 Executive Vice President since March 1984. Senior Vice President from September 1981 to March 1984 and General Counsel since September 1981.\nCharles L. McNairy 47 Executive Vice President since September 1993 and Treasurer and Chief Financial Officer since September 1992. Senior Vice President from September 1992 to September 1993. Vice President - Finance from January 1985 to September 1992, except from April 1987 to September 1988.\nJuanita I. Kerrigan 47 Vice President and Secretary since September 1980.\nExecutive Officers of the Registrant -- continued\nG. Patrick Settles 45 Vice President since November 1986 and Assistant General Counsel since September 1983.\nJohn J. Yanopoulos 37 Vice President -- Finance and Controller since September 1992. Assistant Vice President from May 1990 to September 1992 and Corporate Controller since May 1989. Formerly Senior Audit Manager, Kenneth Leventhal and Company from 1986 to 1989.\nThe above executive officers have held their present positions with Avatar for more than five years, except as otherwise noted.\nNo director or executive officer of Avatar has any family relationship with any other director or executive officer of Avatar.\nPART II\nItem 5.\nItem 5. Market for Registrant's Common Stock and Related Stockholder Matters\nThe Common Stock of Avatar Holdings Inc. is traded through the National Market System of the National Association of Securities Dealers Automated Quotation System (\"NASDAQ\") under the symbol AVTR. The approximate number of record holders of Common Stock at February 28, 1994, was 9,100.\nHigh and low quotations, as reported, for the last two years were:\nAvatar has not declared any cash dividends on Common Stock since its issuance and has no present intention to pay cash dividends. Avatar is subject to certain restrictions on the payment of dividends as set forth in Item 8, \"Notes to Consolidated Financial Statements\".\nItem 6.\nItem 6. Selected Financial Data\nFIVE YEAR COMPARISON OF SELECTED FINANCIAL DATA Dollars in thousands (except per-share data)\n(1) The Company adopted the installment method for homesite sales effective January 1, 1989. Prior to 1989, Avatar used the full accrual method of profit recognition for homesite sales. During 1993, the sale of the Midwest Water Utilities was completed. (See Results of Operations.)\nItem 7.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands)\nRESULTS OF OPERATIONS\nThe following is management's discussion and analysis of certain significant factors that have affected Avatar during the periods included in the accompanying consolidated statements of operations.\nA summary of the period to period changes in the items included in the consolidated statements of income is shown below.\nOperations for the years ended December 31, 1993, 1992 and 1991 resulted in a pre-tax gain (loss) before the changes in accounting methods and extraordinary item of $18,236, ($4,342) and ($12,307), respectively. The improvement in pre-tax income during 1993 compared to 1992 is primarily attributable to the sale of the Midwest Water Utilities for $62,000 which resulted in a pre-tax gain of $21,822 and an adjustment to the estimated development liability for sold land as a result of the purchase of Rio Rico Utilities of $4,532. The improvement in pre-tax results of operations in 1992 compared to 1991 was primarily attributable to higher profit contributions from the Company's utility operations and lower real estate selling expenses.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued\nRESULTS OF OPERATIONS -- continued\nAvatar uses the installment method of profit recognition for homesite sales. Under the installment method the gross profit on recorded homesite sales is deferred and recognized in income of future periods, as principal payments on contracts are received. Fluctuations in deferred gross profit result from deferred gross profit on current homesite sales less recognized deferred gross profit on prior years' homesite sales.\nIn accordance with the Company's business plan, the Company continued its gradual transition from selling predominantly Avatar- owned homesites to providing a diversified mix of products and services including introducing additional housing products, developing amenities and support facilities, expanding vacation ownership operations, expanding property management services and converting land holdings into income producing operations. Avatar's business plan also established objectives of modifying the Company's historic homesite sales program with the goal of maintaining or slightly increasing homesite sales volume. A slight improvement in consumer confidence and the economy combined to enable the Company to achieve budgeted levels for homesite sales volume in 1993. The 1993 average selling prices of housing and homesites were comparable to 1992 levels.\nGross real estate revenues increased 15% during 1993 when compared to 1992 and decreased 7.9% during 1992 when compared to 1991. The increase in real estate revenues for 1993 when compared to 1992 is primarily a result of increased housing and homesite sales volume. Real estate expenses increased $2,594 or 5.8% in 1993 when compared to 1992 and decreased $7,831 or 14.9% in 1992 when compared to 1991. The increase in real estate expenses for 1993 when compared to 1992 is primarily a result of an increase in cost of products sold due to the increase in real estate sales. Margins have improved based on a reduction in related costs as a percentage of real estate sales and a more profitable sales mix of increased homesite and housing sales for 1993 when compared to 1992. The decline in real estate revenues and expenses for 1992 when compared to 1991 resulted primarily from decreased homesite and housing sales during 1992.\nUtility revenues decreased $7,252 or 13.6% during 1993 when compared to 1992 and increased $4,078 or 8.3% during 1992 when compared to 1991. Utility expenses decreased $1,991 or 5.4% during 1993 when compared to 1992 and increased $1,173 or 3.3% during 1992 when compared to 1991. Utility revenues decreased in 1993 as a result of the sale of the Midwest Water Utilities which closed on August 31, 1993. Utility expenses did not decline correspondingly primarily due to increased expenses relating to postretirement benefit costs. The increases for 1992 when compared to 1991 are due to increases in Avatar's customer base and rate increases. In comparing the remaining utility subsidiaries, revenues increased $1,565 or 6.4% in 1993 when compared to 1992 and expenses increased $4,699 or 38.9% in 1993 when compared to 1992. The increase in expenses is primarily a result of postretirement benefit costs, the amortization of rate case costs, and the accrual of professional fees.\nInterest income decreased $2,411 or 14.7% during 1993 when compared to 1992 and $2,686 or 14.1% during 1992 when compared to 1991. The declines in interest income are attributable to lower average aggregate balances of the Company's contract and mortgage notes receivable portfolio. The\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued\nRESULTS OF OPERATIONS -- continued\naverage balance of Avatar's receivable portfolio was $127,909, $153,053 and $181,550 for 1993, 1992 and 1991, respectively. This decrease in interest income was partially offset by earnings from Avatar's investment securities of $903, $479 and $927 for 1993, 1992 and 1991, respectively.\nPre-tax gain on sale of subsidiaries of $21,822 in 1993 is a result of the sale of the Midwest Water Utilities which generated net proceeds of approximately $59,371.\nOther revenues for 1993 includes a reduction of the estimated development liability for sold land of $4,532 as a result of the purchase of Rio Rico Utilities.\nGeneral and administrative expenses increased $811 or 10.4% in 1993 compared to 1992 and $196 or 2.6% during 1992 when compared to 1991. The increases in 1993 and 1992 are primarily a result of incentive compensation recorded for senior officers and an increase in professional fees. Additionally, an increase in real estate revenue contributed to the increase for 1993.\nInterest expense decreased $2,822 or 15.3% in 1993 when compared to 1992 and $738 or 3.8% during 1992 when compared to 1991. These decreases are attributable to an overall decrease in notes, mortgage notes and other debt outstanding during 1993 and lower interest rates during 1992 than in 1991.\nLIQUIDITY AND CAPITAL RESOURCES\nAvatar's primary business activities, which include homesite sales, land development and utility services, are capital intensive in nature. Avatar expects to fund its operations and capital requirements through a combination of cash and investment securities on hand, operating cash flows and external borrowings.\nIn 1993, net cash provided by operating activities amounted to $9,925 and resulted primarily from operations including principal payments on contracts receivable of $21,249. Net cash provided by investing activities of $14,823 in 1993 resulted from the proceeds from the sale of subsidiaries of $59,371 and proceeds from the sale of securities of $17,444 reduced by investments in property, plant and equipment of $11,567 and investments in securities of $50,425. Net cash used in financing activities of $20,214 resulted primarily from the principal payment on revolving lines of credit and long-term borrowings of $48,538 and the purchase of treasury stock of $27,000 less net proceeds from revolving lines of credit and long-term borrowings of $26,121 and proceeds from the issuance of common stock in conjunction with the redemption/conversion of the 5-1/4% Debentures (as defined below) of $30,340.\nAvatar renegotiated certain of its existing bank credit lines and established a new credit line, thereby increasing its secured lines of credit from $36,200 at December 31, 1992, to $45,534 at December 31, 1993. Avatar's unsecured credit lines were decreased from $44,500 at December 31, 1992, to $15,000 at December 31, 1993. The unused portions of these credit lines were $17,000 and $10,325 for the secured and unsecured lines, respectively, at December 31, 1993. Included in these lines of credit is a new line of credit entered into during 1993, secured by investments, which had\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued\nLIQUIDITY AND CAPITAL RESOURCES -- continued\nan outstanding balance at December 31, 1993 of $13,000 and will mature during the fourth quarter of 1994. Also included is an amended and restated line of credit with a balance outstanding at December 31, 1993 of $15,534 collateralized by certain contracts receivables and due May 31, 1995.\nAvatar has planned utility construction for 1994 totaling approximately $22,000. Additionally, the Company has planned land development expenditures of $9,700 during 1994, which will result in additional homesite inventory and preservation of development permits. It is anticipated that land development and utility construction expenditures for 1994 will be funded by operating cash flow and borrowings from external sources.\nOn June 4, 1993 the Company called for the redemption of all its outstanding 5-1/4% convertible-purchase subordinated debentures due May 1, 2007 (the ``5-1/4% Debentures ) at a redemption price of 100% of the principal amount plus accrued and unpaid interest from January 15, 1993 through the redemption date of July 4, 1993. The principal purpose of the redemption was to reduce the Company's annual interest expense, improve its liquidity and increase its stockholders' equity. Holders were entitled to convert their 5-1/4% Debentures into shares of the Company's common stock at a conversion price of $23.00 per share provided they paid in cash an amount equal to the principal amount of the 5-1/4% Debentures being converted, for which they received additional shares of common stock equal to the number issued on conversion. A total of $30,917 principal amount of the 5-1/4% Debentures were converted and 2,688,276 shares of common stock were issued. The remaining $57 principal amount of 5-1/4% Debentures were redeemed as of July 4, 1993. The net result of this transaction, after expenses, was an increase in cash of $30,340, a decrease in debt of $30,973 and an increase in stockholders' equity of $60,835.\nThe closing of the sale of the Midwest Water Utilities took place on August 31, 1993, with an aggregate selling price of $62,000, resulting in a pre-tax gain of $21,822.\nThe Company has invested approximately $51,000 in investment securities which are classified as trading. The Company intends to continue to actively trade such securities in an effort to generate profits and will reinvest such profits until such time as the Company 's cash requirements necessitate the use or partial use of the portfolio proceeds. Avatar's investment portfolio at December 31, 1993 includes $20,045 invested in corporate bonds rated B- or above by Moody's and/or Standard and Poor's and $12,775 invested in non-rated bonds of companies which are in bankruptcy and have defaulted as to payments of principal and interest on such bonds. These bonds are thinly traded and may require sixty to ninety days to liquidate. The portfolio also includes an unsecured claim on a company in bankruptcy of $5,689 which is not readily marketable, $7,020 of equity securities, $1,661 of money market accounts and $3,994 of U.S. Goverment and Agency securities. As of December 31, 1993, $39,932 of the investments serves as collateral for a secured line of credit with an outstanding balance of $13,000.\nOn September 30, 1993 the Company purchased 1,000,000 shares of the Company's common stock from the estate of Peter J. Sharp for $27.00 per share resulting in a decrease in cash of $27,000 and a corresponding decrease in stockholders' equity. These shares are being held in the Company's treasury for future corporate purposes.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued\nLIQUIDITY AND CAPITAL RESOURCES -- continued\nAvatar's Board of Directors has authorized expenditures for the purchase of Avatar's 8% and 9% senior debentures. During 1993, Avatar expended $31 for the purchase of its 8% senior debentures and $1,106 for the purchase of its 9% debentures. As of December 31, 1993, the remaining authorization for such expenditures was $4,301.\nAs a result of the proceeds received from the sale of the Midwest Water Utilities and the redemption/conversion of the 5-1/4% Debentures, net of the funds expended for the stock repurchase, the Company believes it has sufficient capital resources to satisfy anticipated liquidity requirements.\nManagement does not anticipate a significant change in interest rates for 1994, and accordingly, does not expect Avatar's primary business activities to be adversely affected by interest rates. Avatar's homesite sales are not dependent upon the customer obtaining third party financing. A high interest rate environment would be likely to adversely affect Avatar's real estate results of operations and liquidity because certain of Avatar's debt obligations are tied to prevailing interest rates. Increases in interest rates affecting the Company's utility operations generally are passed on to the consumer through the regulatory process.\nEFFECTS OF INFLATION AND ECONOMIC CONDITIONS\nInflation has had a minimal impact on Avatar's operations over the past several years, and management believes its effect has been neither significant nor greater than its effect to the industry as a whole. It is anticipated that the impact of inflation on Avatar's operations for 1994 will not be significant.\nIMPACT OF TAX INSTALLMENT METHOD\nIn 1992, 1991, 1989 and 1988, the Company elected the installment method for recording a substantial amount of its homesite sales in its federal income tax return, which deferred taxable income into future fiscal periods. As a result of this election, the Company may be required to pay compound interest on certain federal income taxes in future fiscal periods attributable to the taxable income deferred under the installment method. The Company believes that the potential interest amount, if any, will not be material to its financial position and results of operations of the affected future periods.\nRETIREMENT PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The Company adopted this statement in 1993, as required. This statement requires the accrual of postretirement benefits (such as health care benefits) during the years an employee provides services. These benefits for retirees are currently provided only to the employees of the Company's utility subsidiaries. The costs of these benefits were previously expensed on a pay-as-you-go basis. The accrual for postretirement benefit costs at December 31, 1993 amounted to $712.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands) -- continued\nRETIREMENT PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS--continued\nAs discussed in Notes J and K to the consolidated financial statements, the weighted average discount rate used in determining both the projected benefit obligation for the Company's defined benefit pension plan and the accumulated postretirement benefit obligation for its postretirement benefit plan is 8%. If the Company were to lower the discount rate by 1/2% in 1994, it would result in an increase in the obligation. To illustrate, a decrease in the discount rate from 8% to 7-1/2% in determining the projected benefit obligation for the Company's defined benefit pension plan, would increase the obligation by approximately $275 and pension expense by approximately $44. The same change in discount rate in estimating the accumulated postretirement benefit obligation for the Company's defined benefit postretirement plan, would increase the obligation by approximately $200. Because the Company has elected to record the transition obligation for postretirement benefits over 20 years, as allowed by Statement No. 106, the effect of reducing the discount rate from 8% to 7-1/2% in 1994 would be less than $30.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data\nReport of Independent Certified Public Accountants.......... 20\nConsolidated Balance Sheets -- December 31, 1993 and 1992... 21\nConsolidated Statements of Operations -- For the years ended December 31, 1993, 1992, 1991.............................. 22\nConsolidated Statements of Stockholders' Equity -- For the years ended December 31, 1993, 1992, 1991................. 23\nConsolidated Statements of Cash Flows -- For the years ended December 31, 1993, 1992, 1991............................... 24\nNotes to Consolidated Financial Statements.................. 26\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nStockholders and Board of Directors Avatar Holdings Inc.\nWe have audited the accompanying consolidated balance sheets of Avatar Holdings Inc. and subsidiaries as of December 31, 1993, and 1992, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1993. Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and related schedules are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Avatar Holdings Inc. and subsidiaries at December 31, 1993 and 1992, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nAs discussed in Note A to the consolidated financial statements, in 1993 the Company changed its methods of accounting for income taxes, investments and postretirement benefits other than pensions.\n/s/ ERNST & YOUNG\nMiami, Florida February 23, 1994, except for the third paragraph of Note R, as to which the date is March 1, 1994\nAVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in thousands)\nSee notes to consolidated financial statements.\nAVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Operations (Dollars in thousands except per share data)\nSee notes to consolidated financial statements.\nAVATAR HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in thousands except per-share data)\n(a) $1 par value per share; 15,500,000 shares authorized and 12,715,448, 10,026,956, and 10,020,827, shares issued at December 31, 1993, 1992 and 1991, respectively, including treasury stock. (b) Retained earnings is subsequent to the October 1, 1980 Plan of Reorganization. (c) Treasury stock included 3,620,346 shares at December 31, 1993 and 2,620,346 shares at December 31, 1992 and 1991.\nThere are 5,000,000 authorized shares of preferred stock, none of which are issued.\nSee notes to consolidated financial statements.\nAVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows (Dollars in Thousands)\nAVATAR HOLDINGS INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows -- continued (Dollars in Thousands)\nSUPPLEMENTAL SCHEDULE OF NON-CASH TRANSACTIONS\nSUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION\nSUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES\nSee notes to consolidated financial statements.\nAVATAR HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1993 (Dollars in thousands except per-share data)\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation:\nThe consolidated financial statements include Avatar Holdings Inc. and its subsidiaries (\"Avatar\"). All significant intercompany accounts and transactions have been eliminated in consolidation.\nGeneral:\nAvatar is principally engaged in the business of developing and selling improved and unimproved real estate, single and multifamily residential housing and providing water and wastewater utility services.\nRestricted Cash:\nRestricted cash represents collections of monthly payments on pledged mortgage notes receivable. These collections will be applied to reduce the related mortgage trust notes (See Note H).\nLand Inventories:\nLand inventories are stated at the lower of cost or estimated net realizable value. Cost includes expenditures for acquisition, construction, development and carrying charges. Interest costs incurred during the period of land development, when applicable, are capitalized as part of the cost of such projects. Land acquisition costs are allocated to individual land parcels based upon the relationship that the estimated sales prices of specific parcels bear to the total sales price of the entire community. Construction and development costs are added to the value of the specific parcels for which the costs are incurred.\nRevenues:\nThe Company uses the installment method of profit recognition for sales of homesites and vacation ownership units. Under the installment method, the gross profit on recorded sales is deferred and recognized in income of future periods as principal payments on related contracts are received. Under the installment method, deferred profit is included in the balance sheet, as a reduction of contracts receivable, until recognized.\nSales of housing units are recognized in full upon the transfer of title to a purchaser. Revenues from commercial land and bulk land sales are recognized in full at closing, provided the purchaser's initial investment is adequate, all financing is considered collectible, and Avatar is not obligated to perform significant future activities.\nUtility revenues are recorded as the service is provided.\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- continued\nProperty, Plant and Equipment:\nProperty, plant and equipment are stated at cost and depreciation is computed principally by the straight line method over the estimated useful lives of the assets. Depreciation, maintenance and operating expenses of equipment utilized in the development of land are capitalized as land inventory cost.\nProperty Held for Sale:\nProperty held for sale consists principally of utility property, plant and equipment related to certain water and wastewater utilities which were held for sale at December 31, 1992, and which were sold during 1993. Such assets are reflected at historical cost.\nIncome Taxes:\nEffective January 1, 1993, the Company adopted Financial Accounting Standards Board (\"FASB\") Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Under Statement No. 109, the liability method is used in accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse. Prior to the adoption of Statement No. 109, income tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rates in effect in the year the difference originated (deferred method).\nAs permitted by Statement No. 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of adopting Statement No. 109 resulted in a charge to net income during the first quarter of 1993 of $964. The cumulative effect of adopting Statement No. 109 for Avatar's utility subsidiaries was not credited or charged to net income, but was recorded as a regulatory liability or regulatory asset in accordance with accounting procedures applicable to regulated enterprises. The regulatory liabilities and regulatory assets will generally be amortized to income or expense over the useful life of the utility system and reflect probable future revenue reductions or increases from ratepayers. The effect of the change on income from continuing operations for the year ended December 31, 1993 was not material.\nDeferred Customer Betterment Fees:\nAmounts collected from customers for utility improvements are classified as \"Deferred Customer Betterment Fees\". These fees will be reclassified to \"Contributions in Aid of Construction\" when service to the customer begins.\nContributions in Aid of Construction:\nAdvances from real estate developers and other direct contributions to utility subsidiaries for plant construction are recorded as \"Contributions in Aid of Construction\". To the extent required by regulatory agencies, the account balance is amortized over the depreciable life of the utility plant as an offset to depreciation expense.\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- continued\nInvestments:\nIn May 1993, the FASB issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" which, among other things, requires companies to classify certain debt and equity securities as \"held to maturity\", \"available for sale\" or \"trading.\"\nThe Company elected to adopt Statement No. 115 as of December 31, 1993, and has classified all of its investment portfolio as trading. This category is defined as including debt and marketable equity securities held for resale in anticipation of earning profits from short-term movements in market prices. Trading account securities are carried at fair value which was $51,184 at December 31, 1993. Subsequent to the initial adoption of Statement No. 115, both realized and unrealized gains and losses will be included in net trading account profit. The cumulative effect as of December 31, 1993 of adopting Statement No. 115 was an increase in net income of $388 (net of income taxes of $238) or $.04 per share.\nPostretirement Benefits:\nIn 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This statement requires the accrual of postretirement benefits (such as health care benefits) during the years an employee provides services. These benefits for retirees currently are provided only to the employees of the Company's utility subsidiaries. The costs of these benefits were previously expensed on a pay-as-you-go basis.\nNet Income Per Common Share:\nNet income per common share is computed on the basis of the weighted average number of shares outstanding plus common stock equivalents, if any, that would result from the dilutive effect of the assumed conversion (and associated purchase) of the 5-1/4% convertible-purchase subordinated Debentures. In 1993, $30,917 of the Company's 5-1/4% convertible-purchase subordinated Debentures were converted into 2,688,276 shares of common stock. The result of this redemption and conversion was dilutive for the year ended December 31, 1993. The primary and fully diluted computations assume the actual conversion occurred at the beginning of the year.\nReclassifications:\nCertain 1992 and 1991 financial statement items have been reclassified to conform with 1993 presentation.\nNOTE B - REAL ESTATE SALES\nThe components of real estate sales are as follows:\nNOTE C - INVESTMENTS\nAvatar's investment portfolio at December 31, 1993 includes $20,045 invested in corporate bonds rated B- or above by Moody's and/or Standard and Poor's and $12,775 invested in non-rated bonds of companies which are in bankruptcy and have defaulted as to payments of principal and interest on such bonds. These bonds are thinly traded and may require sixty to ninety days to liquidate. The portfolio also includes an unsecured claim on a company in bankruptcy of $5,689 which is not readily marketable, $7,020 of equity securities, $1,661 of money market accounts and $3,994 of U.S. Government and Agency securities.\nFair values for actively traded debt securities and equity securities are based on quoted market prices on national markets. Fair values for thinly traded investment securities are generally based on prices quoted by investment brokerage companies.\nAt December 31, 1992 investments securities consisted of U.S. Treasury Notes and Bills. Investments securities at December 31, 1992 are carried at cost which approximates market value.\nNOTE D - CONTRACTS, MORTGAGE NOTES AND OTHER RECEIVABLES\nContracts, mortgage notes and other receivables are summarized as as follows:\nContracts and mortgage notes receivable are generated through the sale of homesites at various sales offices located throughout the northeast, midwest and west coast of the United States. A significant portion of the contracts and mortgage notes receivable at December 31, 1993, resulted from sales made to customers in the northeast. Contracts receivable are collectible primarily over a ten year period and bear interest at rates primarily ranging from 7 1/2% to 12% per annum (weighted average rate 9.9%). A contract receivable is considered delinquent if the scheduled installment payment remains unpaid 30 days after its due date. Delinquent principal amounts of contracts and mortgage notes receivable at December 31, 1993, and 1992 were $13,442 or 11.5% and $18,365 or 13.3%, respectively. Scheduled maturities for the five years subsequent to 1993 are: 1994 - $16,072; 1995 - $19,289; 1996 - $20,209; 1997 - $19,546 and 1998 - $16,285.\nNOTE E - LAND AND OTHER INVENTORIES\nInventories consist of the following:\nNOTE F - ESTIMATED DEVELOPMENT LIABILITY FOR SOLD LAND\nThe estimated cost to complete required land and utility improvements in all areas designated for homesite sales is summarized as follows:\nThese estimates are based on engineering studies of quantities of work to be performed based on current estimated costs. These estimates are reevaluated annually and adjusted accordingly.\nA major portion of the estimated development liability for sold land relates to utility extensions for homesites at Avatar's Arizona community (Rio Rico) which were sold prior to 1980. At Rio Rico, Avatar entered into various service and construction agreements with Citizens Utilities Company (Citizens), a non-related company, generally providing for Avatar to construct certain utility facilities and deed them to Citizens. Avatar's expenditures, related to the construction of some of these facilities, are expected to be reimbursed from Citizens' present and future customers. Some of these reimbursable amounts are determined by specific formulas. The recovery of these expenditures is dependent upon the community attaining an occupancy and/or usage level sufficient to allow reimbursement prior to the expiration of the agreements. During 1993, Avatar purchased Citizens Utilities' water and wastewater treatment division thereby eliminating the portion of the existing agreement relating to water and wastewater extensions, leaving only the electrical portion.\nAvatar may be obligated to advance to its utility subsidiary approximately $9,200 (current costs) to complete water and wastewater utility facilities at its Poinciana subdivision. These possible future obligations are based on internal engineering studies and are not included in the estimated development liability discussed above. As such, past and future expenditures are expected to be recovered from customers' fees and future revenues.\nExpenditures, net of recoveries, for homesite improvement costs totaling $29,933 are estimated as follows: 1994-$8,967, 1995-$8,381 and $12,585 thereafter. Because the timing of the expenditures after 1995 is dependent upon certain future occurrences beyond Avatar's control, projection by year after 1995 is not presently practicable.\nNOTE G - PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment and accumulated depreciation consist of the following:\nDepreciation charged to operations during 1993, 1992 and 1991 was $6,524, $7,607 and $6,373, respectively, net of amortization of contributions in aid of construction of $2,917, $2,632 and $2,532, during 1993, 1992 and 1991, respectively.\nNOTE H - NOTES, MORTGAGE NOTES AND OTHER DEBT Notes, mortgage notes and other debt are summarized as follows:\nNOTE H - NOTES, MORTGAGE NOTES AND OTHER DEBT - continued\nAt December 31, 1993, Avatar had unsecured bank credit lines of $15,000 and secured bank credit lines of $45,534. The unused portions of the unsecured and secured lines were $10,325 and $17,000, respectively. Interest rates for borrowings under these lines range from 4 1/2% to 6% on the unsecured bank credit lines and from 4 3/4% to 6 1/4% on the secured bank credit lines at December 31, 1993. Additionally, certain credit lines provide for fixed rate borrowing pursuant to Eurodollar interest rates. Under the terms of these agreements Avatar is restricted from paying dividends with certain exceptions and is required to maintain a minimum net worth as defined. The secured lines are collateralized by certain contracts and mortgage notes receivable of $20,712 and investment securities of $39,932 at December 31, 1993.\nIn July 1992, Avatar issued $51,160 of 7% Mortgage Trust Notes, pursuant to the securitization of a portion of its homesite receivables. The notes mature on December 15, 2002, however, the Company expects the notes to be repaid in approximately 36 months through the collection of principal payments, including principal prepayments and late collections and all interest payments, net of servicing fee and other adjustments on the mortgage loans. Additionally, all liquidation proceeds with respect to the mortgage loans, proceeds from the sale of property acquired through foreclosure or deed-in-lieu of foreclosure proceedings and proceeds from the purchase of mortgage loans by the issuer are required to be applied to these notes. The balance of these notes at December 31, 1993 was $32,439.\nMaturities of notes, mortgage notes and other debt at December 31, 1993, are as follows:\nMaturities for 1994 include approximately $15,633 related to the Company's bank credit lines. There is no assurance that Avatar will be able to obtain satisfactory extensions or refinancing of these or other credit lines.\nInterest capitalized during 1993, 1992 and 1991 amounted to $381, $772, and $746, respectively.\nProperty, plant and equipment and inventory pledged as collateral for notes, mortgage notes and other indebtedness had a net book value of approximately $151,000 at December 31, 1993.\nNOTE I - MINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES\nAs of December 31, 1993 and 1992, preferred stock outstanding is as follows:\nAvatar's utility subsidiary's 9% cumulative preferred stock issue provides for redemption to occur no earlier than March 1, 1997, in whole or in part; however, a minimum of $1,800 of the preferred stock must be redeemed per annum beginning in 1997. A redemption of all outstanding shares shall occur no later than March 1, 2001.\nMaturities of preferred stock are as follows: 1997-$1,800, 1998 - $1,800 and $5,458 thereafter.\nCharges to operations recorded as \"Other Expenses\" relating to preferred stock dividends of subsidiaries amounted to $1,261 in 1993, $1,544 in 1992, and $1,231 in 1991.\nNOTE J - RETIREMENT PLANS\nAvatar has two defined contribution savings plans that cover substantially all employees. Under one of the savings plans, Avatar contributes to the plan based upon specified percentages of employees' voluntary contributions. The other savings plan does not provide for contributions by Avatar.\nAvatar's non-contributory defined benefit pension plan covers substantially all employees of its subsidiary, Avatar Utilities Inc. The benefits are based on years of service and the employees' compensation during the highest 5 out of the last 10 years of employment. Avatar's funding policy is to contribute amounts to the plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974.\nNOTE J - RETIREMENT PLANS - continued\nThe following table sets forth the defined benefit plan's funded status as of December 31, 1993, 1992 and 1991 and the retirement expense recognized in the consolidated statements of income for the years then ended.\nThe weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 8% and 6%, respectively, at December 31, 1993, 1992 and 1991. The expected long-term rate of return on plan assets for 1993, 1992 and 1991 was 8%.\nAt December 31, 1993, and 1992, the plan assets are invested in a group annuity contract with a major insurance company. Approximately 70% and 80%, respectively, of the plan assets at December 31, 1993 and 1992, are invested in a general asset fund of the insurance company that is comprised primarily of fixed income securities. The remaining assets are invested in equity securities, public bonds and cash equivalents in the insurance company's separate accounts.\nNOTE K - POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nAvatar's utility subsidiary sponsors a defined benefit postretirement plan that provides medical and life insurance benefits to both salaried and nonsalaried employees after retirement. The postretirement medical and life insurance plan is non-contributory.\nAvatar's utility subsidiary's funding policy for its postretirement plan is to fund on a pay-as-you-go basis. Prior to 1993, the expense was also measured on this basis. In 1993, the Company adopted FASB Statement No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which requires accounting for postretirement benefits on an accrual basis. The effect of adopting Statement No. 106 increased net periodic postretirement benefit expense by $712 for 1993. Postretirement expense for 1992 and 1991 has not been restated.\nThe following table sets forth the plan's status as of December 31, 1993:\nFor measurement purposes, a 13% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1993; the rate of increase was assumed to decrease gradually to 6% for the year 2000 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by 1 percentage point each year would increase the accumulated postretirement benefit obligation as of December 31, 1993 by $626 and the aggregate of the service and interest cost components of net periodic postretirement benefit for the year then ended by $122.\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation is 8%.\nNOTE L - LEASE COMMITMENTS\nAvatar leases the majority of its administration and sales offices under operating leases that expire at varying times through 1999. Rental expenses for the years 1993, 1992 and 1991 were $1,186, $1,513, and $2,037, respectively. Minimum rental commitments under noncancelable operating leases as of December 31, 1993 were as follows: 1994 - $954; 1995 - $929; 1996 - $923; 1997-$746; 1998 - $618; and thereafter - $1,512.\nNOTE M - ACCRUED AND OTHER LIABILITIES\nAccrued and other liabilities are summarized as follows:\nAs of December 31, 1993, the Company had agreements with four executive officers providing as incentive compensation a cash payment to each officer (to the extent vested), within ten days following the respective fifth anniversary date of the respective agreement (or the termination date, if earlier), in an amount equal to the excess of a formula amount based upon the closing prices of Avatar common stock during a specified period prior to the respective fifth anniversary date (or termination date, if earlier) over the closing price of Avatar common stock on the date of the respective agreement. Each of these executive officers will vest in the rights to this incentive compensation with respect to one-fifth thereof on each of the first through fifth anniversaries, subject to certain terms and conditions of the contracts should their employment status change prior to the fifth anniversary. For the year ended December 31, 1993, the Company recorded incentive compensation of $469 associated with these agreements. The liability for incentive compensation included in other liabilities at December 31, 1993 and 1992 is $754 and $285, respectively. (See Note R - Contingencies)\nNOTE N - INCOME TAXES\nAvatar Holdings Inc. is the successor in interest to GAC Corporation. GAC, together with certain of its subsidiaries, was reorganized pursuant to Chapter X of the Federal Bankruptcy Act of 1898. The Bankruptcy Court confirmed the Trustees' Plan of Reorganization and issued a final decree on October 16, 1981, discharging the Trustees from their duties.\nUnder the installment method of tax reporting for homesite sales, Avatar anticipates that its 1993 consolidated federal income tax return will reflect a net operating loss carryforward of approximately $18,000, which expires in years 2003 through 2004. The net operating loss carryforward was generated after the reorganization as a result of electing the installment method of reporting homesite sales for tax purposes. In addition, investment tax credits and alternative minimum tax credit carryforwards of approximately $5,000 are available, a portion of which expires in years 1994 to 2001. These\nNOTE N - INCOME TAXES - continued\ncarryforwards have not been examined by the Internal Revenue Service. The Company has recorded a valuation allowance of $33,000 with respect to the deferred income tax assets which remain after offset by the deferred income tax liabilities. Included in the valuation allowance for deferred income tax assets is approximately $9,000 which, if utilized, will be credited to additional paid-in capital.\nDeferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liabilities as of December 31, 1993 are as follows:\nThe provision for income taxes consists of the following:\nDeferred income tax credits result from timing differences in the recognition of certain expenses for tax and financial reporting purposes. For the years ended December 31, 1992 and 1991, the principal components of deferred income tax credits are the theoretical income tax related to the interest discount\nNOTE N - INCOME TAXES - continued\non debentures issued as part of the reorganization and the deferred income tax attributable to the difference between book and income tax depreciation on certain utility assets with long useful lives.\nA reconciliation of income tax expense (credit) to the expected income tax expense (credit) at the federal statutory rate of 35% for the twelve months ended December 31 is as follows:\nIn 1992, 1991, 1989 and 1988, the Company elected the installment method for recording a substantial amount of its homesite sales in its federal income tax return, which deferred taxable income into future fiscal periods. As a result of such election, the Company may be required to pay compound interest on certain federal income taxes in future fiscal periods attributable to the taxable income deferred under the installment method. The Company believes that the potential interest amount, if any, will not be material to its financial position and results of operations of the affected future periods.\nNOTE O - SALE OF SUBSIDIARIES\nOn January 30, 1993, the Company entered into stock purchase agreements for the sale of its Midwest Water Utilities located in Indiana, Missouri, Ohio, and Michigan. The closing of the sale of the midwest water utilities took place on August 31, 1993, with an aggregate selling price of $62,000, resulting in a pre-tax gain of $21,822, subject to post-closing adjustments.\nNOTE P - REDEMPTION/CONVERSION OF 5-1/4% CONVERTIBLE-PURCHASE SUBORDINATED DEBENTURES\nOn June 4, 1993 the Company called for the redemption of all its outstanding 5-1/4% convertible-purchase subordinated Debentures due May 1, 2007 at a redemption price of 100% of the principal amount plus accrued and unpaid interest from January 15, 1993 through the redemption date, July 4, 1993. Holders were entitled to convert their 5-1/4% Debentures into shares of the Company's common stock at a conversion price of $23.00 per share provided they paid in cash an amount equal to the principal amount of the 5-1/4% Debentures being converted, for which they received additional shares of common stock equal to the number issued on conversion. A total of $30,917 principal amount of the 5-1/4% Debentures were converted and 2,688,276 shares of common stock were\nNOTE P - REDEMPTION/CONVERSION OF 5-1/4% CONVERTIBLE-PURCHASE SUBORDINATED DEBENTURES - continued\nissued. The remaining $57 principal amount of 5-1/4% Debentures were redeemed as of July 4, 1993. The net result of this transaction, after expenses, was an increase in cash of $30,340, a decrease in debt of $30,973 and an increase in stockholders' equity of $60,835.\nNOTE Q - TREASURY STOCK PURCHASE\nOn September 30, 1993 the Company purchased 1,000,000 shares of the Company's common stock from the estate of Peter J. Sharp at a purchase price of $27.00 per share. These shares are being held in the Company's treasury for future corporate purposes.\nNOTE R - CONTINGENCIES\nAvatar is involved in various pending litigation matters primarily arising in the normal course of its business. Although the outcome of these and the following matters can not be determined, it is the opinion of management that the resolution of these matters will not have a material effect on Avatar's business or financial position.\nOn October 1, 1993, the United States, on behalf of the U.S. Environmental Protection Agency, filed a civil action against a utility subsidiary of Avatar in the U.S. District Court for the Middle District of Florida. (United States vs. Florida Cities Water Company, Civil Action No. 93-281-C1) The complaint alleges that the subsidiary's wastewater treatment plant in North Fort Myers, Florida, committed various violations of the Clean Water Act, 33 U.S.C. S1251 et seq., including (1) discharge of pollutants without an operating permit from October 1, 1988 to October 31, 1989; (2) discharging from an unpermitted discharge location from November 1, 1989 until July 14, 1992; and (3) discharging pollutants in excess of permit limitations at various times from July 1991 to June of 1992. The government is seeking the statutory maximum civil penalties of $25,000 per day, per violation based upon the allegations. The Subsidiary strongly believes that there are mitigating factors as well as valid legal defenses that could reduce or eliminate the imposition of monetary sanctions.\nOn March 1, 1994, the Wisconsin Department of Natural Resources (the \"Department\") sent Avatar notice that the Department had recently issued a second Record of Decision (\"ROD\") in connection with the Edgerton Sand & Gravel Landfill site (the \"Site\"). The ROD calls for the City of Edgerton's public water supply system to be extended to the owners of private wells in the vicinity of the Site. The ROD also states that other work related to soil and groundwater remedial action would be required at the Site. The Department demanded that all potentially responsible parties (\"PRP's\") associated with the Site organize into a PRP group to undertake the implementation of the ROD. Avatar was previously identified as a PRP by the Department. Avatar believes that it is not liable for any claims by any governmental or private party in connection with the Site.\nOn February 25, 1994, the Company's former President and Chief Executive Officer commenced a lawsuit against Avatar and others claiming damages arising out of his termination of his employment purportedly for \"Good Reason\" (as defined in his employment agreement.) He also seeks to recover damages from Avatar for libel and slander and from the other defendants based on their alleged malicious interference with his employment agreement. Avatar denies that he had Good Reason to terminate his employment agreement. Avatar does not believe there is any valid basis for his claims, and various affirmative defenses have been asserted. Avatar also has asserted counterclaims against him for breach of contract, promissory estoppel and improper inducement in connection with amendments to his employment agreement.\nNOTE S - FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS\nNOTE S - FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS -- continued\n(a) Avatar's businesses are primarily conducted in the United States. (b) In computing operating profit, interest has been reflected separately. (c) Intersegment revenues contain primarily intercompany interest and management fees charged to affiliates. (d) Identifiable assets by segment are those assets that are used in the operations of each segment. General corporate assets are principally cash, receivables and investments. (e) No significant part of the business is dependent upon a single customer or group of customers. (f) Cable TV, mortgage and hotel and recreational operations which primarily serve Avatar communities do not qualify individually as separate reportable segments and are included in the real estate segment. (g) General corporate expenses are included in the real estate segment.\nNOTE T- FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying amounts and fair values of the Company's financial instruments at December 31, 1993, are as follows:\nThe following methods and assumptions were used by the Company in estimating the fair value of financial instruments:\nCash and restricted cash: The carrying amount reported in the balance sheet for cash approximates its fair value.\nInvestments: The carrying amount in the balance sheet for investments is at fair market value which is generally determined by quoted market prices.\nContracts, mortgage notes and other receivables: The fair value amount of the Company's contracts, mortgage notes, and other receivables are estimated based on a discounted cash flow analysis.\nNotes, mortgage notes and other debt: The carrying amounts of the Company's borrowings under its short-term bank credit lines approximate their fair value. The fair values of the Company's mortgage obligations, mortgage bonds, and promissory notes are estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.\nNOTE T- FAIR VALUE OF FINANCIAL INSTRUMENTS - continued\nSenior debentures: The fair values of the Company's Senior and Subordinated debentures are estimated based on quoted market prices.\nMortgage trust notes: The carrying amount in the balance sheet for mortgage trust notes approximates its fair value. The current market rate for similar types of borrowing arrangements approximates the rate of the mortgage trust notes.\nNOTE U - QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data for 1993 and 1992 is as follows:\n(1) Net revenues include homesite sales which are recorded on the installment method of profit recognition.\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures.\nNot applicable. PART III\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant\nA. Identification of Directors\nThe information called for in this item is incorporated by reference to Avatar's 1994 definitive proxy statement (under \"Election of Directors\") to be filed with the Securities and Exchange Commission on or before April 30, 1994.\nB. Identification of Executive Officers\nFor information with respect to the executive officers of Avatar, see \"Executive Officers of the Registrant\" at the end of Part I of this report.\nItem 11.\nItem 11. Executive Compensation\nThe information called for by this item is incorporated by reference to Avatar's 1994 definitive proxy statement (under the caption \"Executive Compensation and Other Information\") to be filed with the Securities and Exchange Commission on or before April 30, 1994.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and Management\nThe information called for by this item is incorporated by reference to Avatar's 1994 definitive proxy statement (under the captions \"Principal Stockholders\" and \"Security Ownership of Management\") to be filed with the Securities and Exchange Commission on or before April 30, 1994.\nItem 13.\nItem 13. Certain Relationships and Related Transactions\nNone\nPART IV\nItem 14.\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nFinancial Statements and Schedules:\nSee Item 8 \"Financial Statements and Supplementary Data\" on Page 17 of this report.\nSchedules:\nI - Marketable Securities and Other Investments V - Property, Plant and Equipment VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment VIII - Valuation and Qualifying Accounts IX - Short-Term Borrowings X - Supplementary Income Statement Information\nSchedules other than those listed above are omitted, since the information required is not applicable or is included in the financial statements or notes thereto.\nExhibits:\n3(a) * Certificate of Incorporation, as amended (previously filed as an exhibit to the Form 10-K for the year ended December 31, 1986).\n3(b) By-laws, as amended through March 24, 1994 (filed herewith).\n4(a) * Instruments defining the rights of security holders, including indenture for 8% senior debentures (previously filed as an exhibit to the Form 8-K dated as of September 12, 1980).\n4(b) * Supplemental Indenture for 8% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n4(c) * Indenture for 9% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n4(d) * Indenture for 5-1/4% convertible-purchase subordinated debentures dated May 1, 1987 (previously filed as an exhibit to Form 10-Q for the period ended March 31, 1987).\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K -- continued\n10(a) * Consulting Agreement, dated as of December 31, 1990, by and between Avatar Properties Inc. and John Sladkus (previously filed as an exhibit to Form 10-K for the year ended December 31, 1990).\nConsulting Agreement, dated as of December 31, 1990, by and between Avatar Utilities Inc. and John Sladkus (previously filed as an exhibit to Form 10-K for the year ended December 31, 1990).\n10(b) * 1 Employment Agreement, dated as of June 15, 1992, by and between Avatar Holdings Inc. and Lawrence Wilkov (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n10(c) * 1 Employment Agreement, dated as of June 15, 1992, by and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n10(d) 1 Amendment to Employment Agreement, dated as of March 1, 1994, by and between Avatar Holdings Inc. and Edwin Jacobson (filed herewith).\n10(e) * Four separate Stock Purchase Agreements dated January 30, 1993, with respect to the sale of the Registrant's utilities located in Indiana, Missouri, Ohio and Michigan, respectively (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(f) * Agreement dated January 30, 1993, with respect to the transactions contemplated by the Stock Purchase Agreements (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(g) * Guarantee by the Registrant (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(h) * Guarantee by American Water Works Company, Inc. (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(i) 1 Incentive Compensation Agreement, dated as of January 18, 1993 by and between Avatar Holdings Inc. and Dennis Getman (filed herewith).\n10(j) 1 Incentive Compensation Agreement, dated as of September 9, 1993 by and between Avatar Holdings Inc. and Charles McNairy (filed herewith).\n10(k) Revolving Credit Agreement between Avatar Properties Inc. and BHF Bank dated November 30, 1993 (filed herewith).\n11 Statement Re: Computation of per share earnings (filed herewith).\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K -- continued\n22 Subsidiaries of the Registrant (filed herewith).\nReports on Form 8-K:\nNo reports on Form 8-K were filed during the quarter ended December 31, 1993.\n* These exhibits are incorporated by reference and are on file with the Securities and Exchange Commission.\n1 Employment and compensation agreements.\nSCHEDULE I - MARKETABLE SECURITIES AND OTHER INVESTMENTS AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands, except number of shares)\n(1) Corporation in Bankruptcy/Principal and Interest in Default\nSCHEDULE V - PROPERTY, PLANT AND EQUIPMENT AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)\nSCHEDULE VI - ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPEMNT AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)\n(1) The annual provisions for depreciation have been computed principally in accordance with the following ranges of rates:\nUtility, plant and equipment 1.5% to 10% Other property, plant and equipment 5% to 20%\n(a) Charged principally to estimated cost of development of land sold and amortization of contributions in aid of construction.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)\n(1) Charged to operations as a reduction of revenues. (2) Uncollectible accounts written off (3) Credited principally to interest income or allowance for doubtful accounts upon write-off of uncollectible accounts. (4) Valuation allowance for deferred tax assets recorded in conjunction with the adoption of FASB Statement No. 109.\nSCHEDULE IX - SHORT-TERM BORROWINGS AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION AVATAR HOLDINGS INC. AND SUBSIDIARIES (Dollars in thousands)\nAmounts for royalties not presented as such amounts are less than one percent of total revenue.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nAVATAR HOLDINGS INC.\nDated: March 24, 1994 By: /s/Charles L. McNairy Charles L. McNairy, Executive Vice President, Treasurer and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.\nDated: March 24, 1994 By: /s/Geoffrey C. Hazard, Jr. Geoffrey C. Hazard, Jr., Director and Audit Committee Member\nDated: March 24, 1994 By: /s/J. Edward Houston J. Edward Houston, Director, Chairman of the Audit Committee and Executive Committee Member\nDated: March 24, 1994 By: /s/Edwin Jacobson Edwin Jacobson, Director, Chairman of the Executive Committee, President and Chief Executive Officer\nDated: March 24, 1994 By: /s/Leon T. Kendall Leon T. Kendall, Director and Audit Committee Member\nDated: March 24, 1994 By: /s/Leon Levy Leon Levy, Chairman of the Board of Directors and Executive Committee Member\nDated: March 24, 1994 By: /s/Martin Meyerson Martin Meyerson, Director and Audit Committee Member\nDated: March 24, 1994 By: /s/William Porter William Porter, Director and Audit Committee Member\nDated: March 24, 1994 By: /s/Fred Stanton Smith Fred Stanton Smith, Director and Executive Committee Member\nDated: March 24, 1994 By: /s/Henry King Stanford Henry King Stanford, Director\nDated: March 24, 1994: By: Lawrence Wilkov, Director\nDated: March 24, 1994 By: /s/John J. Yanopoulos John J. Yanopoulos, Vice-President - Finance and Controller\nExhibit Index\n3(a) * Certificate of Incorporation, as amended (previously filed as an exhibit to the Form 10-K for the year ended December 31, 1986).\n3(b) By-laws, as amended through March 24, 1994 (filed herewith)........................................60\n4(a) * Instruments defining the rights of security holders, including indenture for 8% senior debentures (previously filed as an exhibit to the Form 8-K dated as of September 12, 1980).\n4(b) * Supplemental Indenture for 8% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n4(c) * Indenture for 9% senior debentures dated as of December 19, 1992 (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n4(d) * Indenture for 5-1/4% convertible-purchase subordinated debentures dated May 1, 1987 (previously filed as an exhibit to Form 10-Q for the period ended March 31, 1987).\n10(a) * Consulting Agreement, dated as of December 31, 1990, by and between Avatar Properties Inc. and John Sladkus (previously filed as an exhibit to Form 10-K for the year ended December 31, 1990).\nConsulting Agreement, dated as of December 31, 1990, by and between Avatar Utilities Inc. and John Sladkus (previously filed as an exhibit to Form 10-K for the year ended December 31, 1990).\n10(b) * Employment Agreement, dated as of June 15, 1992, by 1 and between Avatar Holdings Inc. and Lawrence Wilkov (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n10(c) * Employment Agreement, dated June 15, 1992, by 1 and between Avatar Holdings Inc. and Edwin Jacobson (previously filed as an exhibit to Form 10-K for the year ended December 31, 1992).\n10(d) Amendment to Employment Agreement, dated as of March 1, 1994, by and between Avatar Holdings Inc. and Edwin Jacobson (filed herewith).................80\n10(e) * Four separate Stock Purchase Agreements dated January 30, 1993, with respect to the sale of the Registrant's utilities located in Indiana, Missouri, Ohio and Michigan, respectively (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(f) * Agreement dated January 30, 1993, with respect to the transactions contemplated by the Stock Purchase Agreements (previously filed as an exhibit to Form 8- K dated as of February 3, 1993).\nExhibit Index -- continued\n10(g) * Guarantee by the Registrant (previously filed as an exhibit to Form 8-K dated as of February 3, 1993). 10(h) * Guarantee by American Water Works Company, Inc. (previously filed as an exhibit to Form 8-K dated as of February 3, 1993).\n10(i) 1 Incentive Compensation Agreement, dated as of January 18, 1993 by and between Avatar Holdings Inc. and Dennis Getman (filed herewith)......................82\n10(j) 1 Incentive Compensation Agreement, dated as of September 9, 1993 by and between Avatar Holdings Inc. and Charles McNairy (filed herewith)............... 93\n10(k) Revolving Credit Agreement between Avatar Properties Inc. and BHF Bank dated November 30, 1993 (filed herewith)..........................................102\n11 Statement Re: Computation of per share earnings (filed herewith)...................................138\n22 Subsidiaries of the Registrant (filed herewith)..........................................139\n* These exhibits are incorporated by reference and are on file with the Securities and Exchange Commission.\n1 Employment and Compensation agreements."},"word_count":{"kind":"number","value":13298,"string":"13,298"},"character_count":{"kind":"number","value":87375,"string":"87,375"}}},{"rowIdx":296,"cells":{"filename":{"kind":"string","value":"60519_1993.txt"},"id":{"kind":"string","value":"60519_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"60519"},"text":{"kind":"string","value":"ITEM 1. Business\nGeneral\nLouisiana-Pacific Corporation, a Delaware corporation, is a major forest products firm headquartered in Portland, Oregon. It manufactures lumber, pulp, structural and other panel products, hardwood veneers, windows and doors and cellulose insulation. It operates 129 plants and mills in 27 U.S. states, Mexico, and three provinces in Canada, and has approximately 13,000 employees. It distributes its products primarily through distributors and home centers, and to a minor extent through its own distribution centers.\nThe business of Louisiana-Pacific Corporation and its wholly-owned subsidiaries (except where the context otherwise requires, hereinafter referred to collectively as \"the registrant\" or \"L-P\") is generally divided into two industry segments: building products and pulp. For 1993, building products accounted for approximately 97 percent of the registrant's gross sales revenues, compared to approximately 3 percent for pulp. With respect to operating profit in 1993, building products contributed approximately 111 percent, offset by an 11 percent loss for pulp.\nBuilding Products\nLumber. The registrant is among the three largest producers of lumber in the United States. The registrant has 22 Western (whitewood and redwood) sawmills with an annual production capacity of 1,370 million board fee (MMBF), while its 28 Southern sawmills have an annual production capacity of 945 MMBF. Lumber represented 33 percent of the registrant's sales revenue in 1993, down from 53 percent in 1980. The registrant's sawmills produce a variety of standard U.S. dimension lumber as well as specialty grades and sizes, primarily for the North American home building market. A sawmill in Ketchikan, Alaska, produces lumber for export in the traditional sizes used in the Japanese building industry, but has the capability of switching to standard U.S. dimensions. The registrant also operates a planing mill in El Sauzal, Mexico.\nPanel Products. The registrant manufactures plywood and a variety of reconstituted panel products, including Inner-Seal(R) oriented strand board (OSB) and such other panel products as industrial particleboard, medium density fiberboard, and hardboard. In recent years, the registrant has emphasized development and expansion of its reconstituted panel product lines. While such products accounted for 6 percent of the registrant's sales in 1980, they comprised 33 percent of its sales in 1993. Plywood sales have risen from 12 percent of sales in 1980 to 15 percent of sales in 1993.\n- 1-\nThe largest consumption of panel products is for structural uses in building and remodeling such as subfloors, walls and roofs. The total structural panel market in the United States (plywood, OSB and other waferboards) is approximately 26 billion square feet annually, of which plywood currently constitutes about 17 billion square feet. In recent years, environmental pressure on timber harvesting, especially in the West, has resulted in reduced supplies and higher costs, causing many plywood mills to close permanently. The lost volume from those closed mills (approximately 2 billion square feet annually according to industry sources) has been replaced by reconstituted structural panel products. The registrant operates seven plywood plants in the South with a combined annual capacity of 1.5 billion square feet.\nThe registrant is the largest domestic producer of oriented strand board through 17 Inner-Seal(R) OSB plants with an aggregate annual capacity of approximately 3.5 billion square feet. Approximately 50 percent of the registrant's 1993 sales volume in this category came from higher margin specialty products such as tongue and groove subflooring, siding, soffit and facia.\nThe registrant's other reconstituted panel products-- industrial particleboard, medium density fiberboard, and hardboard--produced at a total of seven plants, are used primarily in the manufacture of furniture and cabinets.\nOther Building Products. The registrant's new fiber gypsum wallboard, known as FiberBond(TM), is made from gypsum and waste paper and has improved capabilities over standard wallboard. Other FiberBond(TM) products include fire retardant sheathing and underlayment. The registrant's first fiber gypsum plant, with a production capacity of 78 million square feet, is the first of its kind in North America, although a similar product is manufactured in Europe. The plant began operations in Nova Scotia, Canada, in early 1991. A second plant is scheduled for start-up in mid-1994 in East Providence, Rhode Island.\nSeven plants in Ohio and one in Nevada manufacture windows and doors.\nThe registrant produces various hardwood veneers at a plant in Wisconsin with both rotary and sliced manufacturing processes. These veneers are sold to customers who overlay the veneers on other materials for use in paneling, furniture and cabinets.\nThe registrant has three engineered I-joist plants located in Red Bluff, California, Fernley, Nevada, and Wilmington, North Carolina. Inner-Seal(R) OSB is cut into sections and used as the web for the I-joists.\nThe registrant also produces laminated veneer lumber (LVL) at Wilmington, North Carolina, and Fernley, Nevada. LVL is\n- 2 -\na high grade structural product used where extra strength is required. It is also used as the flange material in I-joists.\nFour plants produce cellulose residential insulation from recycled newspaper under the name Nature Guard(TM). This insulation has a higher R-value than comparable thicknesses of conventional fiberglass insulation.\nPulp\nThe registrant has three pulp mills located in Ketchikan, Alaska, Samoa, California, and Chetwynd, British Columbia, Canada, with a total annual capacity of 612 million short tons. The Chetwynd mill utilizes a state-of-the-art mechanical pulping process and a zero effluent discharge system to produce 100 percent aspen pulp. The Samoa mill can produce bleached kraft pulp by a chlorine-free process, thereby eliminating dioxins.\nCompetition\nThe registrant competes internationally with several thousand forest products firms, ranging from very large, fully integrated firms to smaller firms which may manufacture only one or a few items. The registrant estimates that approximately 25 forest products firms comprise its major competition. The registrant also competes less directly with firms which manufacture substitutes for wood building products. A majority of the products manufactured by the registrant, including lumber, structural panels and pulp, are commodity products sold primarily on the basis of price in competition with numerous other forest products companies.\nIn recent years, the registrant has introduced a number of new value-enhanced products to complement its traditional lumber and panel products, such as Inner-Seal(R) OSB panels, siding and concrete form. These innovative products are made from abundant, smaller-diameter and affordably-priced tree species, as well as treetops and mill shavings. Such trees have generally not been the target of environmentalist pressure, which has seriously restricted wood supplies for much of the industry, especially in the West. Similarly, the registrant's new fiber gypsum and cellulose insulation products utilize wood fiber from waste paper. The registrant believes development of these new products gives it a competitive advantage through lower and more predictable supply costs, resulting in higher profit margins.\nEnvironmental Compliance\nThe registrant is subject to federal, state and local pollution control laws and regulations in all areas in which it has operating facilities. The registrant maintains an accounting reserve for environmental fines and certain other environmental\n- 3 -\ncosts. Over the past two years, $19.2 million in expense related to these costs has been recorded. At December 31, 1993, $8.1 million remained in the reserve. Amounts which may be required in future years depend on the extent to which more stringent pollution control laws, regulations, and policies may be enacted by Congress, the states, localities, or adopted by enforcement agencies. From time to time, the registrant undertakes construction projects for environmental control facilities or incurs other environmental costs which extend an asset's useful life, improves efficiency or improves the marketability of certain properties.\nInformation concerning legal proceedings related to environmental compliance is set forth under Item 3, Legal Proceedings.\nAdditional Statistical Information\nAdditional information regarding the business of the registrant, including segment information, production volumes, and industry product price trends are presented in the following tables labeled \"Sales and Operating Profit by Major Product Group,\" \"Summary of Production Volumes,\" \"Industry Product Price Trends,\" and \"Logs by Source.\" Additional financial information about industry segments is presented in the table labeled \"Industry Segment Information\" located within Part II, Item 8, Notes to the Financial Statements.\nReference is made to Item 2\n\n\nITEM 2. Properties\nThe registrant has three sawmills (redwood and whitewood) located in California with an annual production capacity of 200 MMBF. Twelve other Western sawmills operate in the following states or provinces: Alaska, Montana, Idaho, Oregon, Colorado, Washington, and Sundre, Alberta, Canada. These sawmills have an annual production capacity of 700 MMBF. Western studmills total seven in the following states: Montana, California, Idaho, Wyoming, and Washington, with an annual production capacity of 470 MMBF. The remaining 28 sawmills have an annual production capacity of 945 MMBF and are located in the South in the following states: Louisiana, Texas, Alabama, Florida, Georgia, Mississippi, and North Carolina.\nThe registrant has seven plywood plants located in Texas and Louisiana with a combined annual production capacity of 1.5 billion square feet. There are 17 OSB plants with a combined capacity of 3.5 billion square feet located in Idaho, Texas, Virginia, Alabama, Wisconsin, Maine, Georgia, Colorado, Michigan, Minnesota, Louisiana, and British Columbia, Canada. The registrant has three medium density fiberboard plants located in Alabama, California and Louisiana with a combined capacity of 220 MMSF; three particleboard plants in California, Montana and Texas with a capacity of 350 MMSF; and a hardboard plant in California with an annual production capacity of 210 MMSF.\nUnder the category of other building products, the registrant operates two hardwood veneer plants in Wisconsin, seven window and door plants in Ohio and Nevada, three I-joist and two laminated veneer lumber plants in Nevada, North Carolina, and California, two fingerjoint studmills in Montana and Idaho, and fiber gypsum plants in Nova Scotia, Canada and Rhode Island.\nThe registrant operates three pulp mills with an annual capacity of 612 million short tons in Alaska, California, and British Columbia, Canada.\nOther manufacturing facilities include: a brick plant, four cellulose insulation plants, a cement fiber shake plant, three chip mills, an insulated glass and vinyl extrusion plant, a planing mill, and ten wood treating plants in these various locations: Mexico, Canada, Texas, Alabama, Florida, Georgia, Mississippi, Missouri, Ohio, Maryland, and California. The registrant also operates seven distribution centers in California, Texas, Kansas, and Oklahoma.\nInformation relating to the registrant's production volumes is located in the table labeled \"Summary of Production Volumes\" in Item 1. The information on capacities reflects normal operating rates and normal production mixes under current market conditions. Capacities also consider known constraints such as log supply.\n- 8 -\nAt December 31, 1993, the registrant owned in fee approximately 1,585,900 acres of timberland in the United States. The timberland holdings including whitewoods, fir, pine, redwood, and hardwoods are located in the following states: California, Idaho, Louisiana, Minnesota, North Carolina, Oregon, Texas, Washington, Wisconsin and Wyoming.\nIn addition to its fee-owned timberlands, the registrant has timber cutting rights, under long-term contracts (five years and over) on approximately 110,000 acres and under contracts for shorter periods on approximately 278,000 acres, on government and privately owned timberlands in the vicinities of certain of its manufacturing facilities. Information regarding the sources of the registrant's log requirements is located under the table labeled \"Logs By Source\" in Item 1.\nITEM 3.\nITEM 3. Legal Proceedings\nThe registrant has received a Notice of Violation issued by the U.S. Environmental Protection Agency alleging air emissions violations at the registrant's Dungannon, Virginia, OSB plant. The registrant has also received a Notice of Violation issued by the state of Michigan alleging air emissions violations at the registrant's Newberry, Michigan, OSB plant. The potential costs to the registrant cannot be determined at this time, but are not expected to have a material adverse effect on the registrant.\nThe registrant has been informed that it and one or more employees at its Olathe, Colorado, oriented strand board plant are the targets of a federal grand jury investigation concerning alleged tampering with emissions monitoring equipment and alteration of plant records. The registrant does not know when the investigation will be completed. The registrant began an internal investigation in the summer of 1992 and reported its initial findings of irregularities to governmental authorities in September, 1992.\nOn September 9, 1992, the U.S. Department of Justice filed suit in the U.S. District Court in Anchorage, Alaska, against the registrant's wholly-owned subsidiary Ketchikan Pulp Company (\"KPC\") alleging that the pulp mill in Ketchikan, Alaska, operated by KPC violated the Clean Air Act and the terms of KPC's wastewater discharge permit. The plaintiff seeks to require KPC to correct the alleged violations and also seeks penalties in an unspecified amount. Settlement discussions are currently underway.\nThe registrant has been informed that KPC and one or more employees at KPC's pulp mill are the targets of a federal grand jury investigation concerning wastewater discharges. No charges have been made and the registrant does not know when the investigation will be completed.\n- 9 -\nThe registrant understands that a federal grand jury is investigating possible violations in connection with the disposal\nby a contractor of a transformer containing polychlorinated biphenyls (PCBs) previously located at the registrant's former sawmill at Pendleton, Oregon. The registrant does not know whether it or any of its employees are targets of the investigation.\nOn October 19, 1992, the State of Wisconsin filed a suit against the registrant in state court in Dane County Circuit Court alleging that the registrant's oriented strand board plant at Hayward, Wisconsin, is in violation of state and federal clean air laws. The plaintiff seeks to require the registrant to correct the alleged violations and also seeks penalties in an unspecified amount. The case was settled in 1993 for $550,000.\nManagement of the registrant believes that the outcome of the above matters will not have a materially adverse effect on the consolidated business or financial condition or results of operations of the registrant.\nITEM 4.\nITEM 4. Submission of Matters to a Vote of Security Holders\nNo matter was submitted to a vote of the registrant's security holders during the fourth quarter of 1993.\nExecutive Officers of the Registrant\nThe following table sets forth the name of each executive officer of the registrant (including certain executives whose duties may cause them to be classified as executive officers under applicable SEC rules), the age of the officer and all positions and offices held with the registrant as of March 16, 1994:\nMessrs. Merlo, Eisses, and Paul are also directors of the registrant.\nAll executive officers serve at the pleasure of the board of directors. The terms of office for which they are elected run\n- 10 -\nuntil the next annual meeting of the board of directors, unless earlier removed.\nExcept as set forth below, all of the executive officers have served in their present capacities for more than five years. In January 1994, Mr. Eisses became executive vice president; from June 1992 to January 1994, he was vice president, operations; previously he was general manager of L-P's Northern Division, a position he still holds. Mr. Paul became vice president, operations, in January 1994; previously he was general manager of L-P's Southern Division, a position he continues to hold. Prior to assuming his present position in March 1992, Mr. Simpson was president of Tricon Forest Products, Inc., a forest products broker. Mr. Hebert became treasurer and chief financial officer in January 1994; previously he was L-P's controller, finance.\nPART II\nITEM 5.\nITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe common stock is listed on the New York Stock Exchange, the Dow-Jones newspaper quotations symbol is \"LaPac,\" and the ticker symbol is \"LPX.\" Information regarding market prices for the registrant's common stock is included in the following table labeled \"High and Low Stock Prices.\" Holders of the registrant's common stock may automatically reinvest dividends toward purchase of additional shares of the company's common stock. At March 16, 1994, L-P had approximately 24,600 stockholders of record.\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES HIGH AND LOW STOCK PRICES\nInformation regarding dividends on its common stock declared by the registrant during the past two years is located in the following table.\n- 11 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES QUARTERLY DATA (Dollar amounts in millions except per share)\n- 12 -\nITEM 6.\nITEM 6. Selected Financial Data\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES FINANCIAL SUMMARY (Dollar amounts in millions except per share)\n- 13 -\nITEM 7.\nITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGENERAL\nBuilding Products\nContinued growth in demand for building products fueled by a gradually improving economy in the United States pushed product prices higher. Tightening timber supplies, due to reductions in federal timber harvest volumes, also contributed to the rise in product prices.\nInterest rates remained very favorable for the housing industry. Housing starts, an important measure of building products demand, rose for the fourth consecutive year totaling 1.285 million housing starts in 1993, a 7 percent increase over 1992. The low interest rate environment continues to benefit the repair and remodelling business as well.\nExport markets for building products were quite weak in 1993 as both the Far East and European economies were slow.\nPulp\nHigh worldwide inventories of market pulp combined with extremely depressed economic conditions in many of the countries that use market pulp caused the worst pulp market in recent memory. As a result the industry experienced sizable losses and significant downtime.\nThe following discussion of L-P's operations and financial condition presents specific highlights, and discusses material changes or trends affecting the results of operations. A thorough review of the table \"Financial Summary\" in Item 6 and the tables labeled \"Sales and Operating Profit by Major Product Group,\" \"Summary of Production Volumes,\" \"Industry Product Price Trends,\" and \"Logs by Source\" located in Item 1 will provide a greater understanding of the factors which affect L-P's businesses. Those present, in a tabular format, many of the variables, volumes, operating rates of capacity, representative industry prices, and segment information to enhance the understanding of the financial statements.\n- 14 -\nRESULTS OF OPERATIONS\nBuilding Products\nL-P's building products segment, which in 1993 accounted for 97 percent of total sales, posted a record year, both in terms of sales and profits. Sales in 1993 totalled $2.4 billion compared with $2.0 billion in 1992 and $1.5 billion in 1991. The record sales in 1993 resulted from higher volumes and prices of nearly every building products category. Particularly strong performers in 1993 were panel products: oriented strand board (OSB), plywood and industrial panel products. Also turning solid sales gains was L-P's Other Building Products category which includes, among other products, engineered wood products: I-joists and laminated veneer lumber. Operating profits also were a record in 1993 totaling $562 million compared with $364 million in 1992 and $139 million in 1991.\nOperating profits in each of the past three years have increased despite the rising costs of raw materials. Logs purchased in the open market for sawmills and plywood plants have increased 20-30 percent in each of the past three years. However, purchased wood for L-P's OSB plants has increased 6-8 percent per year in each of the past three years. Sawdust and wood shavings which are the raw materials for industrial panel products have also increased in each of the past three years, primarily due to reductions in sawmill production caused by timber shortages.\nPulp\nSignificant downtime in L-P's pulp mills and record low prices resulted in pulp sales for 1993 of only $85 million compared with $185 million in 1992 and $170 million in 1991. L- P's three pulp mills operated at only 37 percent of normal capacity in 1993 due to market related downtime. Operating profits also reflected the conditions in the pulp industry posting a record $59 million loss versus losses of $20 million in 1992 and $3 million in 1991.\nENVIRONMENTAL UPDATE\nThe greatest challenge confronting L-P today is the ever changing rules and regulations concerning the environment. Our plants face increasingly stringent standards for air and water emissions. Our timberlands are subject to challenges from preservationist groups focused on locking up the nations' timber supply.\nL-P's management is dedicated to meeting these challenges by effectively resolving past environmental issues and committing substantial human and financial resources to its future\n- 15 -\nenvironmental performance. In 1993, the company spent over $100 million in environmental costs and capital projects. Its actions are overseen by the company's Department of Environmental Affairs and by the Environmental Affairs Committee of the board of directors.\nA few examples of the company's environmental performance in the past several years are: the conversion of the company's Samoa, California pulp mill to a chlorine-free process, thereby eliminating dioxins; L-P's agreement with the Environmental Protection Agency (EPA) to install state-of-the-art regenerative thermal oxidization technology at fifteen of its wood panel plants; and, voluntarily eliminating the practice of clear-cutting on the company's timberlands.\nAlthough L-P's corporate policy is to comply with all applicable laws, L-P has in the past been required to pay fines for non-compliance and sometimes litigation has resulted from contested environmental actions. Where the environmental infractions were caused by others, L-P vigorously pursues recovery through legal channels. Listed below are some of the environmental actions recently resolved or currently pending against the company.\nIn 1992, as part of as industry-wide inquiry, L-P received notices of violation from the EPA involving fifteen of its wood panel manufacturing facilities. In 1993, L-P reached a precedent-setting settlement which called for L-P to pioneer pollution control technology at these facilities. The agreement also required L-P to pay an $11.1 million fine to EPA. The fine was paid in 1993, but had been substantially accrued for in 1992.\nL-P has been informed that it and one or more of its employees are the subjects of separate federal grand jury investigations regarding air emissions at its Montrose, Colorado, plant and wastewater discharges at its Ketchikan Pulp Company subsidiary's pulp mill. The investigations have not been completed and no charges against the company or any of its employees have been made. Also, Ketchikan Pulp Company is the subject of a civil enforcement action alleging violations of the Clean Water Act and Clean Air Act. Settlement of this action will likely involve fines and future capital expenditures for environmental projects.\nCertain of L-P's plants or properties held for sale are suspected of having substances in the ground and groundwater that are considered pollutants. Under the direction of the company's Department of Environmental Affairs, corrective action or plans for corrective action are underway.\nManagement believes that the costs of complying with the above actions will not have a material adverse effect on the business, financial condition or results of operations of the company. Generally, L-P expenses the costs of such actions currently as they become known.\n- 16 -\nFINANCIAL POSITION AND LIQUIDITY\nSales for 1993 totalled a record $2.5 billion compared with $2.2 billion in 1992 and $1.7 billion in 1991. Income before cumulative effects of accounting changes for 1993 was $254.4 million, including a $4.4 million charge related to the 1 percent increase in the federal statutory tax rate used to calculate beginning of the year deferred income taxes, compared with net income of $176.9 million in 1992 and $55.9 million in 1991. The cumulative effects of accounting changes relate to adoption of Financial Accounting Standards Board Statement No. 109, \"Accounting for Income Taxes\" which resulted in an after-tax charge of $7.2 million, $.07 per share and Financial Accounting Standards Board Statement No. 106, \"Employers' Accounting for Post-retirement Benefits Other Than Pensions\" which resulted in a net charge of $3.2 million, $.03 per share.\nL-P's financial position and liquidity continues to be among the strongest in the industry. Long-term debt as a percent of total capitalization was only 15.5 percent at December 31, 1993 compared with 22 percent at year end 1992 and 29 percent at year end 1991. The company's ratio of current assets to current liabilities was 1.94 at December 31, 1993, 1.82 at December 31, 1992, and 1.78 at December 31, 1991. Cash and cash equivalents totalled $261.6 million at December 31, 1993, up from $228.1 million at December 31, 1992.\nRecord profits in 1993 also resulted in record cash provided from operations of $438.5 million, compared with $360.3 million in 1992 and $250.2 million in 1991. This strong cash flow has allowed the company to invest in environmental projects, added capacity, continued improvement and upgrading of its existing facilities and make investments in timber. It has also allowed the company to make its mandatory debt repayments and consistently increase cash dividends to its stockholders.\nL-P has an unused line of credit with banks totaling $100 million that is available for general corporate purposes. It maintains short-term credit ratings of A-1 with Standard & Poors and D-1 Plus with Duff & Phelps.\nL-P has a stock purchase program whereby at management's discretion the company may purchase 2.2 million shares of L-P stock. The company purchased 200,000 shares of L-P common stock in 1993.\nIn 1994, L-P plans capital expenditures of about $325- 350 million. Other cash needs include mandatory debt repayments of $105 million and cash dividends, which at the current dividend rate totals $48 million.\n- 17 -\nITEM 8.\n\nITEM 8. Financial Statements and Supplementary Data\nThe consolidated financial statements and accompanying notes to financial statements together with the report of independent public accountants are located on the following pages. Quarterly data for the registrant's latest two fiscal years is located in the tables labeled \"1993 Quarterly Data\" and \"1992 Quarterly Data\" in Item 5.\n- 18 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollar amounts in millions)\n- 19 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Dollar amounts in millions except per share)\n- 20 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in millions)\n- 21 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollar amounts except per share)\n- 22 -\nNOTES TO FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Presentation\nThe consolidated financial statements include the accounts of Louisiana-Pacific Corporation and all of its subsidiaries (L-P), after elimination of intercompany balances and transactions.\nEarnings Per Share\nEarnings per share have been computed based on the weighted average number of shares of common stock outstanding during the periods. The effect of common stock equivalents is not material.\nAll per share amounts and number of shares have been retroactively adjusted for a two-for-one stock split declared on May 4, 1993, for stockholders of record on May 18, 1993. The additional shares were issued on June 8, 1993. In 1992, L-P declared a three-for-two stock split.\nCash and Cash Equivalents\nL-P considers all highly liquid securities with a maturity of three months or less to be cash equivalents. Cash paid during 1993, 1992, and 1991 for interest (net of capitalized interest) was $13.2 million, $21.9 million and $31.2 million. Cash paid during 1993, 1992, and 1991 for income taxes (net of refunds received) was $161.1 million, $93.5 million and $25.3 million.\nAt December 31, 1993, Louisiana-Pacific Canada Ltd., a wholly-owned subsidiary of L-P, had restricted cash balances of USD $16.3 million related to loan agreements which require such balances based on changes in the Canadian dollar relative to the U.S. dollar. These balances are interest-bearing to Louisiana-Pacific Canada Ltd. at short-term interest rates.\nThe carrying amounts of cash and cash equivalents approximates fair value because of the short maturity of those instruments.\nInventory Valuation\nInventories are valued at the lower of cost or market. Inventory costs include material, labor and operating overhead. The\n- 23 -\nNOTES TO FINANCIAL STATEMENTS\nLIFO method is used for most log and lumber inventories. Inventory quantities are determined on the basis of physical inventories, adjusted where necessary for intervening transactions from the date of the physical inventory to the end of the year. The major types of inventories are as follows:\nTimber\nL-P follows an overall policy on fee timber that amortizes timber costs over the total fiber available during the estimated growth cycle. Timber carrying costs, such as reforestation and forest management, are expensed as incurred. Cost of timber harvested includes not only the cost of fee timber but also the amortization of the cost of long-term timber deeds.\nProperty, Plant and Equipment\nL-P uses the units of production method of depreciation for most machinery and equipment which amortizes the cost of equipment over the estimated units that will be produced during its useful life.\nProvisions for depreciation of buildings and the remaining machinery and equipment have been computed using straight-line rates based on the estimated service lives. The effective straight-line rates for the principal classes of property range from approximately 5 percent to 20 percent.\nLogging road construction costs are capitalized and included in land and land improvements. These costs are amortized as the timber volume adjacent to the road system is harvested.\n- 24 -\nNOTES TO FINANCIAL STATEMENTS\nL-P capitalizes interest on borrowed funds during construction periods. Capitalized interest is charged to machinery and equipment accounts and amortized over the lives of the related assets. Interest capitalized during 1993, 1992, and 1991 was $3.5 million, $4.9 million, and $12.8 million.\nL-P defers start-up costs on major construction projects during the start-up phase and amortizes the deferral over seven years. Start-up costs deferred during 1992 and 1991 were $23.8 million and $17.1 million. No start-up costs were deferred during 1993.\nIncome Tax Policies\nDuring the first quarter of 1993, L-P adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which utilizes the liability method whereby deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities using the tax rates applicable at the balance sheet date. Adoption of this standard resulted in a one-time, after tax charge of $7.2 million or seven cents per share. In addition, inventories, timber and timberlands and property, plant and equipment increased by approximately $102.9 million. The effect of adopting this standard did not have a material impact on pre-tax income or income tax expense.\n- 25 -\nNOTES TO FINANCIAL STATEMENTS\nIncome before taxes and cumulative effects of accounting changes for the years ended December 31 was taxed under the following jurisdictions:\nProvision (benefit) for income taxes includes the following:\nL-P increased its U.S. deferred tax liability in 1993 as a result of legislation enacted during 1993 increasing the corporate tax rate from 34 percent to 35 percent effective January 1, 1993. Included in the deferred tax provision is the effect of the 1 percent increase and other tax law changes related to L-P's deferred income tax liability which resulted in a net charge of $4.4 million, or $.04 per share.\n- 26 -\nNOTES TO FINANCIAL STATEMENTS\nThe tax effects of significant temporary differences at December 31, 1993, were as follows:\nL-P's subsidiary, Louisiana-Pacific Canada Ltd. (LPC), has unrealized foreign investment tax credits (ITC) of approximately C$87 million. These credits can be carried forward to offset future tax of LPC. However, these credits expire C$10 million in 1996, C$5 million in 1997, C$20 million in 1999, C$6 million in 2000 and C$46 million in 2001. In addition, LPC has net operating loss (NOL) carryovers of C$36 million. These NOL carryovers expire C$22 million in 1996, C$5 million in 1997, and C$9 million which will not expire.\nThe following table summarizes the differences between the statutory federal and effective tax rate:\nMarketable Securities and Securities Transactions\nThe balance sheet caption \"Investments and Other Assets\" includes marketable equity securities which are carried at the lower of aggregate quoted market value or cost. Unrealized losses\n- 27 -\nNOTES TO FINANCIAL STATEMENTS\non noncurrent marketable equity securities and related income tax effects are accumulated in the other equity adjustment component of stockholders' equity. Realized gains or losses are computed based on actual transaction prices of the securities sold and are reflected in income in the period in which the transaction occurred. At December 31, 1993, the carrying value of these securities approximates the market value.\nForeign Currency Translation\nAssets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rate on the balance sheet date. Revenues, costs, and expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this process are shown separately in stockholders' equity.\nOTHER NOTES TO FINANCIAL STATEMENTS\nAccounts Payable and Accrued Liabilities\n- 28 -\nNOTES TO FINANCIAL STATEMENTS\n- 29 -\nNOTES TO FINANCIAL STATEMENTS\nThe carrying amounts of L-P's long-term debt approximates fair market value since the debt is primarily variable rate debt.\nDebt is generally unsecured except for the Santa Fe Industries debt which is secured by the stock of Kirby Forest Industries, Inc. The Sunpine Forest Products debt is secured by the assets of Sunpine and also guaranteed by L-P. The debt represents 100 percent of Sunpine's obligations, however, L-P Canada Ltd. is a 50 percent joint venture partner. Other installment notes and contracts were incurred primarily through acquisitions of plants and timber.\nMany of L-P's loan agreements contain lender's standard covenants and restrictions. L-P was in compliance with all of the covenants and restrictions of these agreements during 1993 and 1992.\nL-P has a $100 million revolving credit facility with a group of banks. Any borrowings under the credit facility will be due and payable in 1994. The interest rate to be used for the credit line is based on one of three variable interest rate formulas. L-P pays a commitment fee on the unused credit line. There were no borrowings in 1993 or 1992.\nThe weighted average interest rate for all debt at December 31, 1993, and 1992 was 4.3 percent and 4.6 percent. Required repayment of principal for long-term debt is as follows:\nRetirement Plans\nL-P maintains tax-qualified Employee Stock Ownership Trusts (ESOTs), for salaried and certain hourly employees under which 10 percent and 5 percent, respectively, of the eligible employees' annual earnings is contributed to the plans. Approximately 11,000 L-P employees participate in the ESOTs. Fully funded defined benefit plans also supplement the hourly employees' retirement package.\n- 30 -\nNOTES TO FINANCIAL STATEMENTS\nESOT contributions were as follows:\nL-P has a number of pension plans covering its hourly employees. Contributions to its defined benefit plans are based on actuarial calculations of amounts to cover current pension and amortization of prior service cost over periods ranging from 10 to 20 years. Contributions to multi-employer defined benefit plans are specified in applicable collective bargaining agreements.\nThe status of L-P administered pension plans are as follows:\nThe actuarial assumptions used to determine pension expense and the funded status of the plans for 1993 and 1992 were: a discount rate on benefit obligations of 7.5 percent in 1993 and 8.75 percent in 1992, a 3.0 percent increase in future compensation levels in 1993 for active participants and 4.0 percent in 1992, and - 31 -\nNOTES TO FINANCIAL STATEMENTS\nan 8.75 percent expected long-term rate of return on plan assets in 1993 and 9.5 percent in 1992.\nThe assets of the plans at December 31, 1993, and 1992 consist mostly of government obligations, and minor amounts in cash or cash equivalents.\nPension expense included the following components:\nDuring the first quarter of 1993, the Company adopted the Financial Accounting Standards Board Statement No. 106, \"Employers' Accounting for Post-retirement Benefits Other Than Pensions.\" The standard requires employers to record the cost of non-pension retirement benefits during the working years of the employee. Adoption of this standard resulted in a one-time charge of $3.2 million or three cents per share, net of $1.9 million in income taxes, to first quarter 1993 earnings. Additional future costs associated with adopting this new standard are not expected to be material.\nIn November 1992, the Financial Accounting Standards Board issued Statement No. 112, \"Employers' Accounting for Post- employment Benefits.\" L-P does not generally provide post- employment benefits, and therefore adoption of this statement will not have a material effect on the financial statements.\nStock Options and Plans\nL-P grants options to key employees to purchase L-P common stock. Options are granted at 85 to 100 percent of market price. The options become exercisable 20 percent per year beginning one year after the grant date and expire 10 years after the date of grant. The options outstanding at December 31, 1993, are exercisable 1,397,242 shares in 1994, 614,210 shares in 1995,\n595,380 shares in 1996, 143,190 shares in 1997, and 50,640 shares\n- 32 -\nNOTES TO FINANCIAL STATEMENTS\nin 1998. Shares available for granting of options at December 31, 1993, and 1992 were 596,850 and 798,750.\nChanges during 1993 in options outstanding and exercisable were as follows:\nL-P also grants awards under the Louisiana-Pacific Corporation Key Employee Restricted Stock Plan. Shares available for grant at December 31, 1993, were 2,491,500. The shares are issued, at no cost to the employee, only after performance criteria are met. In 1992, the performance criteria was met, and 212,250 shares were issued in 1993. The compensation expense for these shares was recorded in 1992, based on the year-end value, and the additional expense of the value at issuance was recorded in 1993. In 1993, the performance criteria was also met, which resulted in 352,500 shares issued in December of 1993, and 90,000 shares to be issued in 1994. The compensation expense for the shares to be issued in 1994 was recorded in 1993, based on the year-end value.\n- 33 -\nNOTES TO FINANCIAL STATEMENTS\nChanges during 1993 in the Restricted Stock Plan shares were as follows:\nL-P offers employee stock purchase plans to all employees. Under the plans, employees may subscribe to purchase shares of L-P stock over 24 months at 85 percent of the market price. At December 31, 1993, 517,336 shares and 567,830 shares were subscribed at $29.91 and $19.12 per share under the 1993 and 1992 Employee Stock Purchase Plans. On April 30, 1993, L-P issued 264,165 shares to employees at an average price of $17.35 upon completion of the purchase period for the 1991 Employee Stock Purchase Plan.\nLitigation; Environmental Matters\nIn 1992, as part of an overall industry inquiry, L-P and Kirby Forest Industries, a wholly owned L-P subsidiary, received notices of violation from the U.S. Environmental Protection Agency (EPA) against fifteen of its manufacturing facilities. During 1993, L-P reached a precedent-setting environmental settlement with the EPA, which called for L-P and Kirby Forest Industries to pioneer pollution control technology for the entire wood panel products industry. The agreement also required L-P to pay an $11.1 million civil penalty to the Federal government. The payment was made on November 1, 1993, but had been substantially accrued for 1992.\nL-P has been informed that it and one or more of its employees are the subjects of separate federal grand jury investigations regarding air emissions at its Montrose, Colorado, plant and wastewater discharges at its Ketchikan Pulp Company subsidiary's pulp mill. The investigations have not been completed and no charges against the company or any of its employees have been made. Also, Ketchikan Pulp Company is the subject of a civil enforcement action alleging violations of the Clean Water Act and\n- 34 -\nNOTES TO FINANCIAL STATEMENTS\nClean Air Act. Settlement of this action will likely involve fines and future capital expenditures for environmental projects.\nCertain of L-P's plant sites are suspected of having substances in the ground or in the groundwater that are considered pollutants. Under the direction of the company's Department of Environmental Affairs, corrective action or plans for corrective action are underway. Where the pollutants were caused by previous owners of the property, L-P is vigorously pursuing those parties through legal channels.\nIn 1991, L-P reached an agreement with the EPA relating to past violations of wastewater discharge limits from L-P's Samoa, California pulpmill. The amount of the settlement was $3 million, which L-P expensed in the second quarter of 1991.\nAlthough L-P's corporate policy is to comply with all applicable laws, the company has in the past been required to pay fines for non-compliance and sometimes litigation has resulted from contested environmental actions. Also, the items discussed above could result in fines or penalties against the company. However, management believes that any fines or penalties resulting from the matters discussed above will not have a material adverse effect on the business, financial position or results of operations of L-P.\nOther Matters\nL-P and its subsidiaries are party to other legal proceedings. Management believes that the outcome of such proceedings will not have a material adverse effect on the business, financial position or results of operations of L-P.\nCommitments; Timber Cutting Contracts\nL-P is obligated to purchase timber under cutting contracts, primarily with the U.S. Forest Service, which extend to 2004.\n- 35 -\nNOTES TO FINANCIAL STATEMENTS\nThe table below presents L-P's best estimate of its commitment under timber cutting contracts.\nLeases\nThe table below presents L-P's future minimum rental payments under non-cancelable operating leases.\nPayments under all operating leases that were charged to rental expense during 1993, 1992, and 1991 were $7.1 million, $8.7 million and $6.8 million.\nOther\nDuring 1994, L-P plans expenditures of about $325-350 million for plant additions and improvements, timber and logging roads.\n- 36 -\nNOTES TO FINANCIAL STATEMENTS\nIndustry Segment Information\nL-P operates in two major industry segments. The major products included in each segment are detailed further on page 5. Intersegment sales are chips transferred from company-owned building products plants to company-owned pulp mills. All transfers are made at prevailing market prices. Timber and related assets and capital expenditures for such assets have not been allocated to the industry segments as these are a prime source of raw materials for both segments. The cost of logs delivered to the plants and residual fibers are included in the operating results of the segments.\nExport sales were primarily to customers in the Far East, Europe and Canada.\n- 37 -\nNOTES TO FINANCIAL STATEMENTS\nInformation about L-P's industry segments is as follows:\nInformation about L-P's geographic segments is as follows:\n- 38 -\nReport of Independent Public Accountants\nTo the Stockholders and Board of Directors of Louisiana-Pacific Corporation:\nWe have audited the accompanying consolidated balance sheets of Louisiana-Pacific Corporation (a Delaware corporation) and subsidiaries as of December 31, 1993, and 1992, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Louisiana-Pacific Corporation and subsidiaries as of December 31, 1993, and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.\nAs discussed in the notes to the consolidated financial statements, effective January 1, 1993, the Company changed its methods of accounting for income taxes and post-retirement benefits other than pensions.\nArthur Andersen & Co. Portland, Oregon February 4, 1994\nReport of Management\nThe management of Louisiana-Pacific Corporation has prepared the consolidated financial statements and related financial data contained in this Report. The financial statements were prepared in accordance with generally accepted accounting principles appropriate in the circumstances and by necessity include some amounts determined using management's best judgments\n- 39 -\nand estimates with appropriate consideration to materiality. Management is responsible for the integrity and objectivity of the financial statements and other financial data included in the report. To meet this responsibility management maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that accounting records are reliable. Management supports a program of internal audits and internal accounting control reviews to provide assurance that the system is operating effectively.\nThe Board of Directors pursues its responsibility for reported financial information through its Audit Committee, composed of five outside directors. The Audit Committee meets periodically with management, the internal auditors and the independent public accountants to review the activities of each.\n/s/ HARRY A. MERLO\nChairman and President\n/s/ WILLIAM L. HEBERT\nTreasurer and Chief Financial Officer\nFebruary 4, 1994\nITEM 9.\nITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone.\nPART III\nITEM 10.\n\n\nITEM 10. Directors and Executive Officers of the Registrant\nInformation regarding the directors of the registrant is incorporated herein by reference to the material included under the caption \"Item 1 - -Election of Directors\" and \"General\" in the definitive proxy statement to be filed by the registrant for its 1994 annual meeting of stockholders (the \"1994 Proxy Statement\"). Information regarding the executive officers of the registrant is located in Part I of this report under the caption \"Executive Officers of the Registrant.\"\n- 40 -\nITEM 11.\nITEM 11. Executive Compensation\nInformation regarding executive compensation is incorporated herein by reference to the material under the captions \"Compensation Committee--Interlocks and Insider Participation,\" \"Summary Compensation Table,\" \"Aggregated Option/SAR Exercises in Last Fiscal year and Fiscal year-End Options/SAR Values,\" and \"Director's Compensation,\" in the 1994 Proxy Statement.\nITEM 12.\nITEM 12. Security Ownership of Certain Beneficial Owners and Management\nInformation regarding security ownership of certain beneficial owners and management is incorporated herein by reference to the material under the caption \"Holders of Common Stock\" in the 1994 Proxy Statement.\nITEM 13.\nITEM 13. Certain Relationships and Related Transactions\nInformation regarding management transactions is incorporated herein by reference to the material under the captions \"Compensation Committee--Interlocks and Insider Participation\" and \"Management Transactions\" in the 1994 Proxy Statement.\nPART IV\nITEM 14.\nITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nA. Financial Statements and Financial Statement Schedules\nThe financial statements included in this report and the financial statement schedules filed as part of this report are listed in the accompanying index to financial statements and schedules.\nB. Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 1993.\nC. Exhibits\nThe exhibits filed as part of this report or incorporated by reference herein are listed in the accompanying exhibit index. Each management contract or compensatory plan or arrangement is identified in the index.\n- 41 -\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Louisiana-Pacific Corporation, a Delaware corporation (the \"registrant\"), has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 29, 1994 LOUISIANA-PACIFIC CORPORATION (Registrant)\n/s/ WILLIAM L. HEBERT William L. Hebert Treasurer\n________________________________________\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate Signature and Title\nMarch 29, 1994 /s/ HARRY A. MERLO Harry A. Merlo Chairman, President and Director (Principal Executive Officer)\nMarch 29, 1994 /s/ JAMES EISSES James Eisses Executive Vice President and Director\nMarch 29, 1994 /s/ WILLIAM L. HEBERT William L. Hebert Treasurer (Principal Financial Officer)\n- 42 -\nDate Signature and Title\nMarch 29, 1994 /s/ JAMES F. ELLISOR James F. Ellisor Controller, Operations (Principal Accounting Officer)\nMarch 29, 1994 /s/ PIERRE S. DU PONT IV Pierre S. du Pont IV Director\nMarch 29, 1994 /s/ BONNIE F. GUITON Bonnie F. Guiton Director\nMarch 29, 1994 /s/ DONALD R. KAYSER Donald R. Kayser Director\nMarch 29, 1994 /s/ FRANCINE I. NEFF Francine I. Neff Director\nMarch 29, 1994 /s/ CHARLES E. YEAGER Charles E. Yeager Director\n- 43 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nFinancial Statements:\nConsolidated Balance Sheets--December 31, 1993, and 1992.\nConsolidated Statements of Income--years ended December 31, 1993, 1992, and 1991.\nConsolidated Statements of Cash Flows--years ended December 31, 1993, 1992, and 1991.\nConsolidated Statements of Stockholders' Equity--years ended December 31, 1993, 1992, and 1991.\nNotes to Financial Statements.\nReport of Independent Public Accountants.\nFinancial Statement Schedules:\nReport of Independent Public Accountants Covering Financial Statement Schedules\nV - Property, Plant and Equipment\nVI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment\nIX - Short-Term Borrowings\nX - Supplementary Income Statement Information\nAll other financial statement schedules are omitted because they are not applicable or not required.\n- 44 -\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Stockholders and Board of Directors of Louisiana-Pacific Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in this Form 10-K, and have issued our report thereon dated February 4, 1994. Our report on the financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes and postretirement benefits other than pensions. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the index to financial statements and schedules are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nPortland, Oregon February 4, 1994\n- 45 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT SCHEDULE V (Dollar Amounts in Millions)\n- 46 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT SCHEDULE VI (Dollar Amounts in Millions)\n- 47 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES SHORT - TERM BORROWINGS SCHEDULE IX (Dollar Amounts in Millions)\n- 47 -\nLOUISIANA-PACIFIC CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INCOME STATEMENT INFORMATION SCHEDULE X (Dollar Amounts in Millions)\n- 48 -\nEXHIBIT INDEX\nOn written request, the registrant will furnish to any record holder or beneficial holder of the registrant's common stock any exhibit to this report upon the payment of a fee equal to the registrant's costs of copying such exhibit plus postage. Any such request should be sent to: Pamela A. Selis, Director of Corporate Communications, Louisiana-Pacific Corporation, 111 S.W. Fifth Avenue, Portland, Oregon 97204.\nItems identified with an asterisk (*) are management contracts or compensatory plans or arrangements.\nSequential Exhibit Description of Exhibit Page Number\n3.A Restated Certificate of Incorporation of the registrant as amended to date. Incorporated by reference to Exhibit 3(a) to the registrant's Form 10-Q report for the second quarter of 1993.\n3.B Bylaws of the registrant as amended to date. Incorporated by reference to Exhibit 3(b) to the registrant's Form 10-Q report for the second quarter of 1993.\n4.A The registrant's secured note dated December 22, 1986, in the principal amount of $290,000,000 payable to Santa Fe Industries, Inc. Incorporated by reference to Exhibit 2.B to the registrant's Form 8-K report dated as of December 22, 1986 (File No. 1-7107).\n4.B Amendment No. 1 to Secured Note (Exhibit 4.A). Incorporated by reference to Exhibit 4.B to the registrant's Form 10-K report for 1988.\n4.C Rights Agreement as Restated as of February 3, 1991, between the registrant and First Chicago Trust Company of New York as Rights Agent. Incorporated by reference to Exhibit 4 to the registrant's Form 8-K report dated as of March 18, 1991.\nPursuant to Item 601 (b)(4)(iii) of Regulation S-K, the registrant is not filing certain instruments with respect to its long- term debt because the amount authorized under any such instrument does not exceed 10 percent of the total consolidated assets of the registrant at December 31, 1993. The registrant agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.\n- 49 -\nSequential Exhibit Description of Exhibit Page Number\n10.A The registrant's 1984 Employee Stock Option Plan as amended to date. Incorporated by reference to Exhibit 10.B to the registrant's Form 10-K report for 1989.*\n10.B The registrant's 1991 Employee Stock Option Plan. Incorporated by reference to Exhibit 10.B to the registrant's Form 10-K report for 1990.*\n10.C 1992 Non-Employee Director Stock Option Plan and Related Form of Option Agreement. Incorporated by reference to Exhibit 10.C to the registrant's Form 10-K report for 1992.*\n10.D Deferred cash bonus agreement dated May 5, 1986, between the registrant and Harry A. Merlo; and deferred cash bonus agreement dated February 2, 1987, between the registrant and Harry A. Merlo. Incorporated by reference to Exhibit 10.D to the registrant's Form 10-K report for 1986 (File No. 1-7107).*\n10.E Louisiana-Pacific Corporation Directors' Deferred Compensation Plan. Incorporated by reference to Exhibit 10.F to the regi- strant's Form 10-K report for 1986 (File No. 1-7107).*\n10.F(1) Share Purchase Agreement dated as of December 3, 1986, between Santa Fe Industries, Inc., and the registrant. Incorporated by reference to Exhibit 2.A to the registrant's Form 8-K report dated as of December 22, 1986 (File No. 1-7107).\n10.F(2) Pledge Agreement dated December 22, 1986, between the registrant and Santa Fe Industries, Inc. Incorporated by reference to Exhibit 2.C to the registrant's Form 8-K report dated as of December 22, 1986 (File No. 1-7107).\n10.F(3) Amendment No. 1 to Pledge Agreement (Exhibit 10.F(2)). Incorporated by reference to Exhibit 10.F(3) to the registrant's Form 10-K report for 1988.\n10.G(1) Agency Agreement dated as of December 22, 1986, among the registrant and ten banks, including Morgan Guaranty Trust Company of New York as administrative agent. Incorpor- ated by reference to Exhibit 10.H(2) to the registrant's Form 10-K report for 1986 (File No. 1-7107).\n- 50 -\nSequential Exhibit Description of Exhibit Page Number\n10.G(2) Amendment No. 1 to Agency Agreement (Exhibit 10.G(1)). Incorporated by reference to Exhibit 10.G(2) to the registrant's Form 10-K report for 1988.\n10.H(1) The registrant's Key Employee Restricted Stock Plan as amended. Incorporated by reference to Exhibit 10.H(1) to the registrant's Form 10-K report for 1990.*\n10.H(2) Form of Restricted Stock Award Agreement under Exhibit 10.H(1). Incorporated by reference to Exhibit 10.H(2) to the registrant's Form 10-K report for 1992.*\n10.I Lease and Option to Purchase between the registrant as Lessor and Harry A. Merlo as Lessee, as amended. Incorporated by reference to Exhibit 10.I to the regi- strant's Form 10-K report for 1988.\n10.J Distribution Agreement dated as of May 23, 1988, between the registrant and Fibreboard Corporation. Incorporated by reference to Exhibit 2.B to the registrant's Form 8-K report dated as of May 23, 1988.\n10.K The registrant's Supplemental Benefits Plan. Incorporated by reference to Exhibit 10.K to the registrant's Form 10-K report for 1989.*\n11 Louisiana-Pacific Corporation and Subsi- 52 diaries: Calculation of Net Income Per Share For the Year Ended December 31, 1993.\n21 List of subsidiaries of the registrant. 53\n23 Consent of Independent Public Accountants. 54\n- 51 -"},"word_count":{"kind":"number","value":9245,"string":"9,245"},"character_count":{"kind":"number","value":60911,"string":"60,911"}}},{"rowIdx":297,"cells":{"filename":{"kind":"string","value":"10427_1993.txt"},"id":{"kind":"string","value":"10427_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"10427"},"text":{"kind":"string","value":"ITEM 1. BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS\nBausch & Lomb Incorporated is a world leader in the development, manufacture and marketing of products and services for the personal health, medical, biomedical and optics fields.\nBausch & Lomb was incorporated in the State of New York in 1908 to carry on a business which was established in 1853. Its principal executive offices are located in Rochester, New York. Unless the context indicates otherwise, the terms \"Bausch & Lomb\" and \"Company\" as used herein refer to Bausch & Lomb Incorporated and its consolidated subsidiaries. Highlights of the general development of the business of Bausch & Lomb Incorporated during 1993 are discussed below.\nThe Company experienced good progress in 1993. Sales increased to $1,872 million, 10% above the 1992 amount of $1,709 million. Including restructuring charges in 1993, earnings amounted to $156.5 million or $2.60 per share. Excluding these charges, earnings advanced to $193.0 million, or $3.21 per share, a 13% increase over the 1992 amounts of $171.4 million and $2.84 per share.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nInformation concerning sales, business segment earnings and identifiable assets attributable to each of Bausch & Lomb's reportable industry segments is set forth on pages 3440 and 51-52 of the Annual Report and is incorporated herein by reference.\n(c) NARRATIVE DESCRIPTION OF BUSINESS\nBausch & Lomb's operations have been classified into two industry segments: Healthcare and Optics. Below is a description of each segment and information to the extent that it is material to an understanding of the Company's business taken as a whole. In addition, pages 22-32 of the Annual Report are incorporated herein by reference.\nHealthcare\nThe Healthcare segment includes personal health, medical and biomedical products. In the personal health area, major lines include solutions used for the care of contact lenses and for the relief of eye irritation, contact lens accessories, Clear Choice mouthwash, certain over-the-counter pharmaceutical products, the Interplak power toothbrushes and other oral care products, and Curel and Soft Sense skin care products. Medical products include contact lenses and lens materials, prescription drugs, the Miracle- Ear line of hearing aids and Steri-Oss dental implants. Biomedical products include purpose-bred laboratory animals for biomedical research, products derived from specific pathogenfree eggs, and a variety of other biotechnical and professional services provided to the scientific research community.\nThe Company markets its personal health products in the U.S. to practitioners through its own sales force and through drug stores, food stores, and mass merchandisers. Personal health products are also marketed through an extensive international marketing organization. Distribution in many other countries is accomplished through distributors or dealers. Medical products are marketed through the Company's sales force to eyecare and dental care practitioners, independent optical laboratories, and hospitals. Hearing aids are distributed through the Miracle-Ear franchise system. Sales to pharmacies are handled by drug wholesalers, while marketing of medical products outside the U.S. is accomplished through the Company's extensive international marketing organization. In some countries, distribution is handled through dealers or distributors. Biomedical products are sold primarily through the Company's sales force worldwide.\nThe Company acquired Steri-Oss, Inc., a California manufacturer of dental implants, during the first quarter of 1993. The breadth and quality of its line of coated and uncoated titanium implants has earned Steri-Oss an excellent reputation among dental professionals.\nDuring the second quarter of 1993, Bausch & Lomb acquired the Curel and Soft Sense lines of skin care products from S. C. Johnson and Son, Inc. These lines are expected to benefit from the Company's marketing and distribution expertise.\nThe acquisition of Dahlberg, Inc. during the third quarter of 1993 expanded Bausch & Lomb's participation in the hearing care field. Dahlberg is the maker of the Miracle-Ear line of hearing aids, a widely recognized hearing aid brand name, which has over 1,000 franchised locations in the U.S.\nDuring the fourth quarter of 1993, the Company received licenses to product several generic pharmaceuticals in its state- of-the-art, aseptic manufacturing plant in Tampa, Florida. Additional approvals are anticipated during 1994.\nThe Company introduced the Occasions line of contact lenses in 1993. Occasions are worn only once before being discarded and will be especially beneficial in selected situations when contact lenses are preferred over spectacles.\nVivivit Q10 vitamins were introduced in Germany by the Company's Dr. Mann Pharma subsidiary during the second half of 1993. Favorable trade acceptance of this product led to a successful launch.\nOptics\nThe principal products of the Company's Optics segment include sunglasses, binoculars, riflescopes, telescopes and optical thin film applications and products.\nOptical products are distributed worldwide through distributors, wholesalers, manufacturers' representatives, and independent sales representatives. These products are also distributed through the Company's sales force to optical stores, department stores, catalog showrooms, mass merchandisers, sporting goods stores and, in the case of optical thin films, to a variety of industrial customers.\nDuring 1993, the Company launched the Ray-Ban Survivors line of sunglasses. These products feature DiamondHard lens coatings which render glass lenses more scratch resistant. These sunglasses met with good acceptance among active, outdoor oriented consumers.\nThe Company also introduced the Bausch & Lomb Elite riflescope during the year. It features multi-coated optics, durable construction and proven accuracy. It is expected to meet with good aceptance among consumers who demand the highest quality riflescopes.\nRaw Materials and Parts; Customers\nMaterials and components in both of the Company's industry segments are purchased from a wide variety of suppliers and the loss of any one supplier would not adversely affect the Company's business to a significant extent. No material part of the Company's business in either of its industry segments is dependent upon a single or a few customers.\nPatents, Trademarks & Licenses\nWhile in the aggregate the Company's patents are of material importance to its businesses taken as a whole, no single patent or patent license or group of patents or patent licenses relating to any particular product or process is material to either industry segment. The Company actively pursues technology development and acquisition as a means to enhance its competitive position in its business segments.\nIn the healthcare segment, Bausch & Lomb has developed significant consumer, eye care professional and dental care professional recognition of products sold under the Bausch & Lomb, Sensitive Eyes, ReNu, Boston, SeeQuence, Medalist, The Boston Lens, Optima, Soflens, Charles River, VAF/Plus and Interplak trademarks. Bausch & Lomb, Ray-Ban, Wayfarer and Bushnell are trademarks receiving substantial consumer recognition in the optics segment.\nSeasonality and Working Capital\nSome seasonality exists for the Interplak line of power toothbrushes in the Healthcare segment and for sunglasses and sports optics products in the Optics segment. During some periods, the accumulation of inventories of such products in advance of expected shipments reflects the seasonal nature of the products. In general, the working capital practices followed in each of the Company's industry segments are typical of those businesses.\nCompetition\nEach industry segment is highly competitive in both U.S. and non-U.S. markets. In both of its segments, Bausch & Lomb competes on the basis of product performance, quality, technology, price, service, warranty and reliability. In the Optics segment, the Company also competes on the basis of style.\nResearch and Development\nResearch and development constitutes an important part of Bausch & Lomb's activities. In 1993, the Company's research and development expenditures totaled $58 million, as compared to $53 million in 1992 and $49 million in 1991.\nEnvironment\nAlthough Bausch & Lomb is unable to predict what legislation or regulations may be adopted or enacted in the future with respect to environmental protection and waste disposal, existing legislation and regulations have had no material adverse effect on its capital expenditures, earnings or competitive position. Capital expenditures for property, plant and equipment for environmental control facilities were not material during 1993 and are not anticipated to be material in 1994 or 1995.\nNumber of Employees\nBausch & Lomb employed approximately 15,900 persons as of December 25, 1993.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nInformation as to sales, operating earnings and identifiable assets attributable to each of Bausch & Lomb's geographic regions, and the amount of export sales in the aggregate, is set forth on page 51 of the Annual Report and is incorporated herein by reference.\nITEM 2.\n\n\nITEM 2. PROPERTIES\nThe principal manufacturing, distribution and production facilities and other important physical properties of Bausch & Lomb at March 1, 1994 are listed hereafter and grouped under the principal industry segment to which they relate. Certain properties relate to more than one industry segment. Except where otherwise indicated by footnote, all properties shown are held in fee and are not subject to major encumbrances.\nHEALTHCARE\nManufacturing Plants Distribution Centers\nYorba Linda, CA (2) Yorba Linda, CA (2) Sarasota, FL (1) Tampa, FL Tampa, FL Tucker, GA (2) Wilmington, MA (2) Golden Valley, MN (1) Golden Valley, MN (1) Greenville, SC (2) Hauppauge, NY (2) Lynchburg, VA (2) Rochester, NY (1),(2) Turtle Lake, WI (1) (Optics Center) Greenville, SC Turtle Lake, WI (1) North Ryde, Australia (2) Porto Alegre, Brazil Rio de Janeiro, Brazil (2) Kitchener, Canada (2) Beijing, China (2) Berlin, Germany Bhiwadi, India Jakarta, Indonesia (2) Waterford, Ireland (2) Milan, Italy Umsong-Gun (Seoul), Korea Naucalcan, Mexico (2) Barcelona, Spain Madrid, Spain Hastings, United Kingdom\nProduction Facilities\nHollister, CA (2) Brussels, Belgium Lebanon, CT (2) St. Constant, Canada Preston, CT (2) Henfield, England Summerland Key, FL Margate, England Roanoke, IL (2) L'Arbresle Cedex, France Wilmington, MA (2) Lyons, France Windham, ME (2) St. Aubin-les- Elbeuf, France Portage, MI (2) Extertal, Germany O'Fallon, MO (2) Kisslegg, Germany Raleigh, NC (2) Sulzfeld, Germany Omaha, NE (2) Calco, Italy Pittsfield, NH (2) Monticello Brienza, Italy Newfield (Lakeview), NJ (2) Atsugi, Japan Stone Ridge (Kingston), NY Hino, Japan Reinholds, PA (2) Tskuba, Japan (2) Charleston, SC Someren, Netherlands Houston, TX Barcelona, Spain (2) Oregon, WI (2) OPTICS\nManufacturing Plants Distribution Centers\nMountain View, CA (2) Mountain View, CA (2) Oakland, MD Richmond Hill, Canada (2) Rochester, NY (1),(2) Broomfield, CO (Optics Center) Overland Park, KS (2) Rochester, NY Rochester, NY (1), (2) (Frame Center) (Optics Center) San Antonio, TX San Antonio, TX North Ryde, Australia (2) Rio de Janeiro, Brazil (2) Pforzheim, Germany New Territories, Hong Kong (2) Bhiwadi, India Waterford, Ireland (2) Naucalcan, Mexico (2) Nuevo Laredo, Mexico (2)\nCORPORATE FACILITIES\nRochester, NY One Chase Square (23rd, 24th, 25th Floors) (2) Euclid Street (2) 42 East Avenue (2) Optics Center (1),(2) 1295 Scottsville Road (2)\n[FN] (1) This facility is financed under a tax-exempt financing agreement. (2) This facility is leased.\nBausch & Lomb considers that its facilities are suitable and adequate for the operations involved. All facilities are being productively utilized.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\n1. In June 1990, the Company was served with six \"toxic tort\" suits filed against it and approximately 80 other defendants in the 21st Judicial District Court of Louisiana. These suits, which have been certified as a class action, alleged claims for personal injury, property damage and \"fear of cancer\" from waste allegedly generated by the Company and others and transported to an oil reclamation site in Louisiana. Each suit alleges joint and several liability and claims actual and exemplary damages exceeding 10% of the current assets of the Company on a consolidated basis, the Company believes that if its waste is or was present at the site, such waste would have amounted to approximately 0.1% of the site's total waste, and that its share of liability, if any, would be de minimis relative to other defendants' potential liability and that is is not material to the financial condition of the Company. On January 25, 1993, the Company and ten other defendants were dismissed from the action without prejudice, by a motion of the plaintiffs. It is probable that either the plaintiffs or one or more of the defendants will seek to bring the Company back into the proceedings.\n2. Since August 1993, the Company's wholly-owned subsidiary, Dahlberg, Inc., has been served with seven lawsuits by individuals seeking to represent a class of consumers, including one action in the United States District Court for the Northern District of California, five actions in the Fourth Judicial District for the State of Minnesota and one in the Circuit Court, Barbour County, Alabama. Each action has been brought on behalf of alleged purchasers of Miracle-Ear hearing aids equipped with the Clarifier circuitry, which were manufactured and distributed by Dahlberg. The complaints allege that Dahlberg induced plaintiffs and others similarly situated to purchase hearing aids through allegedly false and misleading statements concerning the performance capabilities of the Clarifier circuitry. Plaintiffs allege fraud, negligence, and violation of federal and state statutes and are seeking compensatory and punitive damages in an unstated amount. Dahlberg is vigorously contesting the claims of the plaintiffs, including their claim to be representatives of a class.\n3. In January 1994, the Department of Justice, acting on behalf of the Federal Trade Commission, commenced an action in the United States District Court for the District of Minnesota against Dahlberg, Inc., a wholly-owned subsidiary of the Company. The FTC is seeking civil penalties and injunctive relief, claiming that certain intended use claims in advertisements for hearing aids equipped with the Clarifier circuitry violated a 1976 consent order between the FTC and Dahlberg. The action seeks penalties of up to $10,000 for each publication of the advertisements. Dahlberg is vigorously contesting both the FTC's authority to regulate intended use claims for hearing aids and the allegation that the subject advertising violated the 1976 consent order.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nInapplicable.\nPART II\nITEM 5.\nITEM 5. MARKET FOR BAUSCH & LOMB INCORPORATED'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe sections entitled \"Dividends\" and \"Quarterly Stock Prices\" and table entitled \"Selected Financial Data\" on pages 44, 45 and 64-65, respectively, of the Annual Report are incorporated herein by reference.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nThe table entitled \"Selected Financial Data\" on pages 6465 of the Annual Report is incorporated herein by reference.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe section entitled \"Financial Review\" on pages 34-45 of the Annual Report is incorporated herein by reference.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements, including the notes thereto, together with the sections entitled \"Report of Independent Accountants\" and \"Quarterly Results\" of the Annual Report included on pages 46-63, 63 and 45, respectively, are incorporated herein by reference.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nInapplicable.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF BAUSCH & LOMB INCORPORATED\nInformation with respect to non-officer directors is included in the Proxy Statement on pages 3-7, and such information is incorporated herein by reference. Set forth below are the names, ages (as of March 1, 1994), positions and offices held by, and a brief account of the business experience during the past five years of, each executive officer.\nName and Age Position\nDaniel E. Gill (57) Chairman since 1982, Chief Executive Officer since 1981 and Director since l978.\nRonald L. Zarrella (44) President and Chief Operating Officer since February, 1993; Executive Vice President (1992February, 1993); Senior Vice President and President, International Division (1987-1993); Vice President and President, Subsidiary Operations, International Division (1986-1987), and Director since April, 1993.\nHenry L. Foster (68) Senior Vice President since 1988, and Chairman of the Board since 1947 of Charles River Laboratories, Inc., a subsidiary of the Company; President and Chief Executive Officer, Charles River Laboratories, Inc. (1947- 1991); Vice President (1986-1988).\nJay T. Holmes (51) Senior Vice President, Corporate Affairs since 1983, Secretary since 1981 and Director since l986.\nHarold O. Johnson (59) Senior Vice President since l985 and President, Contact Lens Division since l987; President, International Operations (1985-1987).\nJames E. Kanaley (52) Senior Vice President since l985 and President, Personal Products Division since l987; President, Professional Eye Care Products Group (l985-l987).\nRobert J. Palmisano (49) Senior Vice President since 1992 and President, Eyewear Division since 1988; Vice President (19841992); President, Sports Optics and Scientific Products Group (1986- 1988).\nCarl E. Sassano (44) Senior Vice President since 1992; Vice President (1986-1992); President, Polymer Technology Corporation, a subsidiary of the Company (1983-1992).\nPeter Stephenson (54) Senior Vice President - Finance since March 1994; Vice President and Controller (February 1993- February 1994); Vice President and Corporate Treasurer Warner Lambert Company (1990-1991); Vice President and Corporate Controller - Warner Lambert Company (1987-1990).\nFrank M. Stotz (63) Senior Vice President since March 1994; Senior Vice President, Finance 1991 to March 1994; Partner, Price Waterhouse (1966-1991).\nOmar Casal (44) Vice President and President - Western Hemisphere Division since 1992; General Manager, Bausch & Lomb IOM S.p.A. (1989-1992); General Manager, Bausch & Lomb Australia Pty., Ltd. (1985-1989).\nJames C. Foster (43) Vice President, and President and Chief Executive Officer of Charles River Laboratories, Inc., a subsidiary of the Company, since 1991; Executive Vice President, Charles River Laboratories (19891991); Senior Vice President, Charles River Laboratories and President, Charles River Biotechnical Services (1987-1988); President, Charles River Biotechnical Services and Vice President, Biotechnical Group (1985-1987).\nJames P. Greenawalt (44) Vice President, Human Resources since 1986.\nDiane C. Harris (51) Vice President, Corporate Development since 1981.\nStephen A. Hellrung (46) Vice President and General Counsel since 1985.\nAlexander E. Izzard (56) Vice President and President - AsiaPacific Division since 1990; Area Vice President - Far East, International Division since 1985.\nFranklin T. Jepson (46) Vice President, Communications and Investor Relations since 1986.\nBarbara M. Kelley (47) Vice President, Public Affairs since April, 1993; Staff Vice President, Public Affairs (19911993); Director, Public Affairs (1986-1991).\nAlex Kumar (46) Vice President and President - Europe, Middle East and Africa Division since 1989; Vice President, Europe, Middle East and Africa, International Division since 1988; Vice President, European Subsidiary Operations, International Division (1987-1988); Area Vice President, Europe, International Division (1986-1987).\nJon M. Larson (60) Vice President since 1981 and Vice President, Quality since 1987; Vice President, Regulatory Affairs (1989-1991); Vice President, Technical Services, International Operations (1986-1987).\nStephen C. McCluski (41) Vice President and Controller since March 1994; President - Outlook Eyewear Company (1992February 1994); Vice President Controller, Eyewear Division (1989-1992).\nB. Joseph Messner (41) Vice President since 1989 and President, Sports Optics Division since 1988; Vice President Operations, Sports Optics Division (1987-1988); Vice President and Controller, Sunglass Division (1984-1987).\nAlan H. Resnick (50) Vice President and Treasurer since 1986.\nThomas M. Riedhammer (45) Vice President and President Worldwide Pharmaceuticals since January 1994; Vice President and President Pharmaceutical Division (1992-1993); Vice President - Research and Development, Pharmaceutical Division (1991-1992); Vice President, Paco Pharmaceutical Services, Inc. and President, Paco Research Corp. (1986-1991).\nRobert F. Thompson (40) Vice President since December 1993 and President Polymer Technology Corporation, a subsidiary of the Company (1992-1993); Vice President - U.S. Business Operations, Polymer Technology Corporation (1991-1992); Vice President Marketing, Polymer Technology Corporation (19881991).\nJames J. Ward (56) Vice President - Audit Services since February, 1993; Vice President (1984-1993); Controller (1985-1993).\nExcept for Henry and James Foster, who are father and son, there are no family relationships among the persons named above. All officers serve on a year-to-year basis through the day of the annual meeting of shareholders of the Company, and there is no arrangement or understanding between any of the officers of the Company and any other persons pursuant to which such officer was selected as an officer.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nThe portions of the \"Executive Compensation\" section entitled \"Compensation Tables\" and \"Defined Benefit Retirement Plans\", the second through fourth paragraphs of the section entitled \"Board of Directors\", and the second paragraph of the section entitled \"Related Transactions and Employment Contracts\" included in the Proxy Statement on pages 15-21, 1-2 and 21, respectively, are incorporated herein by reference.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section entitled \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement on pages 8-9 is incorporated herein by reference.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPage 5 and the first paragraph of the section entitled \"Related Transactions and Employment Contracts\" on page 21 of the Proxy Statement are incorporated herein by reference.\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nThe following documents or the portions thereof indicated are filed as a part of this report.\n(a) INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORTS OF INDEPENDENT ACCOUNTANTS.\n1. Data incorporated by reference in Page in Item 8 from the Annual Report Annual Report\nReport of Independent Accountants 63\nBalance Sheet at December 25, 1993 and December 26, 1992 47\nFor the years ended December 25, 1993, December 26, 1992 and December 28,\n1991:\nStatement of Earnings\n46 Statement of Cash Flows\nNotes to Financial Statements 49-63 2. Filed herewith Report of Independent Accountants on Financial Statement Schedules Exhibit (24)\nFor the years ended December 25, 1993, December 26, 1992 and December 28, 1991:\nSCHEDULE II-Amounts Receivable from Page S-1 Related Parties and Underwriters, Promoters and Employees Other Than Related Parties\nSCHEDULE V-Property, Plant and Page S-2 Equipment\nSCHEDULE VI-Accumulated Depreciation Page S-3 and Amortization of Property, Plant and Equipment\nSCHEDULE VIII-Valuation and Qualifying Page S-4 Accounts\nSCHEDULE X-Supplementary Income Page S-5 Statement Information\nAll other schedules have been omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed by the Company during the last quarter of 1993.\n(c) ITEM 601 EXHIBITS\nThose exhibits required to be filed by Item 601 of Regulation S-K are listed in the Exhibit Index immediately preceding the exhibits filed herewith and such listing is incorporated herein by reference. Each of Exhibits (10)-a through (10)-u is a management contract or compensatory plan or arrangement required to be filed as an exhibit to this form pursuant ot Item 14(c) of this report.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBAUSCH & LOMB INCORPORATED\nDate: March 22, 1994 By:/s/ Daniel E. Gill Daniel E. Gill Chairman and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nPrincipal Executive Officer\nDate: March 22, 1994 By:/s/Daniel E. Gill Daniel E. Gill Chairman, Chief Executive Officer and Director\nPrincipal Financial Officer\nDate: March 22, 1994 By:/s/ Peter Stephenson Peter Stephenson Senior Vice President, Finance\nController\nDate: March 22, By:/s/ Stephen C. McCluski\nStephen C. McCluski, Vice President and Controller\nDirectors Franklin E. Agnew William Baldersto n III Bradfo rd R. Boss Ruth R. McMull in John R. Purcel l Linda Johnso n Rice Robert L. Tarnow Alvin W. Trivel piece William H. Waltrip\nKenneth L. Wolfe Ronald L. Zarrella\nDate: March 22, 1994 By:/s/Jay T. Holmes Jay T. Holmes Attorney-in-Fact\nand Director\nEXHIBIT INDEX\nS-K Item 601 No. Document\n(3)-a Certificate of Incorporation of Bausch & Lomb Incorporated (filed as Exhibit (3)-a to the Company's Annual Report on Form 10- K for the fiscal year ended December 29, 1985, File No. 1-4105, and incorporated herein by reference).\n(3)-b Certificate of Amendment of Bausch & Lomb Incorporated (filed as Exhibit (3)-b to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-4105, and incorporated herein by reference).\n(3)-c Certificate of Amendment of Bausch & Lomb Incorporated (filed as Exhibit (3)-c to the Company's Annual report on Form 10-K for the fiscal year ended December 26, 1992, File No. 1-4105, and incorporated herein by reference).\n(3)-d By-Laws of Bausch & Lomb Incorporated, as amended, effective October 28, 1986 (filed as Exhibit (3)-b to the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 1986, File No. 1- 4105, and incorporated herein by reference).\n(4)-a Certificate of Incorporation of Bausch & Lomb Incorporated (filed as Exhibit (4)-a to the Company's Annual Report on Form 10- K for the fiscal year ended December 29, 1985, File No. 1-4105, and incorporated herein by reference).\n(4)-b Certificate of Amendment of Bausch & Lomb Incorporated (filed as Exhibit (4)-b to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-4105, and incorporated herein by reference).\n(4)-c Certificate of Amendment of Bausch & Lomb Incorporated (filed as Exhibit (4)-c to the Company's Annual report on Form 10-K for the fiscal year ended December 26, 1992, File No. 1-4105, and incorporated herein by reference).\n(4)-d Form of Indenture, dated as of September 1, 1991, between the Company and Citibank, N.A., as Trustee, with respect to the Company's Medium-Term Notes (filed as Exhibit 4-(a) to the Company's Registration Statement on Form S-3, File No. 33-42858, and incorporated herein by reference).\n(4)-e Rights Agreement between the Company and The First National Bank of Boston, as successor to Chase Lincoln First Bank, N.A. (filed as Exhibit 1 to the Company's Current Report on Form 8-K dated July 25, 1988, File No. 14105, and incorporated herein by reference).\n(4)-f Amendment to the Rights Agreement between the Company and The First National Bank of Boston, as successor to Chase Lincoln First Bank, N.A. (filed as Exhibit 1 to the Company's Current Report on Form 8-K dated July 31, 1990, File No. 1-4105, and incorporated herein by reference).\n(10)-a Change of Control Employment Agreement with certain executive officers of the Company (filed as Exhibit (10)-a to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 1-4105, and incorporated herein by reference).\n(10)-b The Bausch & Lomb Incorporated Executive Incentive Compensation Plan as restated (filed herewith).\n(10)-c The Bausch & Lomb Supplemental Retirement Income Plan I, as restated (filed as Exhibit (10)-e to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 14105, and incorporated herein by reference).\n(10)-d The Bausch & Lomb Supplemental Retirement Income Plan II, as restated (filed as Exhibit (10)-f to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 14105, and incorporated herein by reference).\n(10)-e The Bausch & Lomb Supplemental Retirement Income Plan III (filed as Exhibit (10)-g to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1992, File No. 1-4105, and incorporated herein by reference).\n(10)-f The Bausch & Lomb Incorporated Long Term Incentive Program, as restated (filed as Exhibit (10)-g to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1985, File No. 14105, and incorporated herein by reference).\n(10)-g Amendment to the Bausch & Lomb Incorporated Long Term Incentive Program (filed as Exhibit (10)-i to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-4105, and incorporated herein by reference).\n(10)-h The Bausch & Lomb Incorporated Long Term Performance Stock Plan I (filed herewith).\n(10)-i Bausch & Lomb Incorporated Long Term Performance Stock Plan II, as amended (filed herewith).\n(10)-j The 1982 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit III-F to the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1982, File No. 1-4105, and incorporated herein by reference).\n(10)-k Amendment to the 1982 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit (10)-l to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-4105, and incorporated herein by reference).\n(10)-l Amendment to the 1982 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit (10)-k to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 1-4105, and incorporated herein by reference).\n(10)-m The 1987 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit I.B to the Company's Registration Statement on Form S-8, File No. 33-15439, and incorporated herein by reference).\n(10)-n Amendment to the 1987 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit (10)-n to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-4105, and incorporated herein by reference).\n(10)-o Amendment to the 1987 Stock Incentive Plan of Bausch & Lomb Incorporated (filed as Exhibit (10)-n to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 1-4105, and incorporated herein by reference).\n(10)-p The 1990 Stock Incentive Plan of Bausch & Lomb Incorporated, as amended (filed as Exhibit (10)-o to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 14105, and incorporated herein by reference).\n(10)-q The Bausch & Lomb Incorporated Director Deferred Compensation Plan, as restated (filed as Exhibit (10)-p to the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 1991, File No. 1-4105, and incorporated herein by reference).\n(10)-r The Bausch & Lomb Incorporated Executive Deferred Compensation Plan, as restated (filed as Exhibit (10)-q to the Company's Annual Report on Form 10-K for the fiscal year ended December 28, 1991, File No. 1-4105, and incorporated herein by reference).\n(10)-s The Bausch & Lomb Incorporated Executive Benefit Plan, as amended (filed as Exhibit (10)-t to the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990, File No. 1-4105, and incorporated herein by reference).\n(10)-t The Bausch & Lomb Incorporated Executive Security Program (filed as Exhibit (10)-s to the Company's Annual Report on Form 10-K for the fiscal year ended December 30, 1989, File No. 1-4105, and incorporated herein by reference).\n(10)-u The Bausch & Lomb Retirement Benefit Restoration Plan (filed as Exhibit (10)-t to the company's Annual Report on Form 10-K for the fiscal year ended December 28, 1991, File No. 1-4105, and incorporated herein by reference).\n(11) Statement Regarding Computation of Per Share Earnings (filed herewith).\n(12) Statement Regarding Computation of Ratio of Earnings to Fixed Charges (filed herewith).\n(13) The Bausch & Lomb 1993 Annual Report to Shareholders for the fiscal year ended December 25, 1993 (filed herewith). With the exception of the pages of the Annual Report specifially incorporated by reference herein, the Annual Report is not deemed to be filed as a part of this Report on Form 10-K.\n(22) Subsidiaries (filed herewith).\n(24) Report of Independent Accountants on Financial Statement Schedules and Consent of Independent Accountants (filed herewith).\n(25) Power of attorney with respect to the signatures of directors in this Report on Form 10-K (filed herewith). EXHIBIT (10)-b\nTHE EXECUTIVE INCENTIVE COMPENSATION PLAN\n1.0 INTRODUCTION\nThe Executive Incentive Compensation Plan is established to provide incentive compensation in the form of a supplement to the base salaries of those officers, managers, and key employees who contribute significantly to the growth and success of the Company's business; to attract and to retain, in the employ of the Company, individuals of outstanding ability; and to align the interests of those who hold positions of major responsibility in the Company with the interests of the Company's shareholders.\n2.0 ELIGIBILITY\nThose members of the executive management group whose duties and responsibilities contribute significantly to the growth and success of the Company's business are eligible. This generally includes all positions in the midmanagement/technical band and above, in Rochester based divisions or functions. The plan may be adopted by nonRochester based divisions.\nThe participant must be on the payroll in an eligible position before July 1 of the plan year, to be eligible for an award.\n3.0 DEFINITIONS\n3.1 A standard incentive award has been established for each salary grade or job band and is expressed as a percentage of period salary (i.e., eligible base salary earnings for the year). Exhibit I defines standard percentage schedules.\nThe standard incentive award is the award payout level which over time, participants, units and the corporation should average, and will be the amount which will be used for financial accrual purposes during the incentive year.\n3.2 An approved incentive is the incentive which has been approved by the Chairman of the Board of directors and the Committee On Management of the Board to be paid by the company to the participant.\nActual incentive award amounts, based upon individual and organizational performance, can vary from 0% for unacceptable performance, or from a minimum of 25% to a maximum of 175% of standard. In any event, an award cannot exceed the maximum.\n4.0 MEASURES OF PERFORMANCE\nEach organizational unit and eligible participant will set performance measures. These will be applied for incentive plan purposes as follows:\n4.1 The \"Organizational Performance Management System\" (OPMS) has been established to evaluate corporate, division, and profit center performance for Executive Incentive Compensation Plan purposes.\nThe OPMS is based upon specific organizational objectives. These objectives are to be agreed upon at the beginning of the plan year. They must be measurable financial categories such as sales, operating earnings, earnings per share, DSO, inventory turns, or quantifiable strategic goals, for example product development, products introduction market share. Performance levels for 5, 4, 3, 2, and 1 ratings are to be defined at the beginning of the plan year for each goal. There will be a pre-determined weighting among the chosen objectives reflecting the priority of those objectives.\nIn general, it is expected that the calculated organizational results will determine the performance rating for the unit. However, after calculation of year end OPMS results, the CEO and COO may make a modification of +20% to the calculated rating, if performance is not accurately reflected in performance measures (i.e., due to general economic, industry change, corporate strategy change, natural disaster). Adjustments must be made in 5% increments.\n4.2 The \"Individual Performance Management System\" (IPMS) for use with the Executive Incentive Plan will consist of five or fewer specific individual objectives. These objectives are to be agreed upon at the beginning of the Plan year. They must be measurable and generally within the participant's control. Further, there will be a predetermined weighting among the objectives reflecting the priority of these objectives. Individual performance will be determined by the participants' supervisor and approved by the Division/Group Presidents or appropriate corporate staff function head.\nIn general, it is expected that the calculated individual results will determine the performance rating. However, the unit or functional officer may make an adjustment of +20% to the calculated ratings if performance is not accurately reflected in performance measures. Adjustments must be made in 5% increments.\n5.0 DEFINITION OF PERFORMANCE\nThe following \"definitions of performance\" are to be utilized for the plan:\n6.0 PROCEDURE FOR BONUS CALCULATION AND APPROVAL\nEach participant's total bonus will be calculated as follows:\n1) The standard bonus (see Section 3.1) is divided into appropriate corporation/unit-individual components (as defined in Section 4.0).\n2) For the organizational components;\nA. The final rating is converted to a percentage factor (see Attachment I conversion table).\nB. The factor is multiplied by the standard organizational bonus.\nC. There is no organizational award granted if final rating is below 2.0.\n3) For the individual component;\nA. The final rating is converted to a percentage factor (see Attachment III conversion table).\nB. The factor is multiplied by the standard individual bonus.\nC. There is no individual award granted if final rating is below 2.0.\n4) To calculate the total bonus, the components are added.\nThe Division Presidents will submit their recommendations for individual incentive awards to their immediate superiors (in some cases only the Chief Operating Officer; in others Group Presidents and COO). In all instances the recommendations for the Corporate awards will be submitted to the Chief Executive Officer for concurrence.\nCorporate function heads will submit their recommendations for individual awards to their immediate superior who will then submit the recommendations to the Chief Executive Officer for concurrence.\n7.0 REMOVAL, TRANSFERS AND TERMINATIONS\n7.1 Participants whose employment with the Company is terminated because of retirement, death, or disability:\n- - After the close of the plan year, but prior to the actual distribution of awards for such year, may be awarded a full incentive award for the plan year. In the case of death, such payment will be made to a beneficiary.\n- - After the beginning, but prior to the end of the plan year, may receive an incentive award for that year based on a prorated calculation reflecting their employment with the Company and participation in the Plan during year. Awards will not be paid for any period less than six months participation in the plan year.\n7.2 Participants who are terminated in the fourth quarter of the year due to a re-structuring which results in job elimination, may receive an incentive award for that year based on a prorated calculation reflecting their employment with the Company and participation in the Plan during that year.\n7.3 Participants transferred during the plan year within the Company will be awarded an incentive payment through the division in which the participant is employed at the end of the plan year. It will be based on the contribution made in each division in which the participant was employed during the year. To this end a written evaluation and rating must be completed by the participant's superior upon transfer. The awarding division will be charged for the full amount of the bonus.\n7.4 Notwithstanding the foregoing, a special prorated incentive award shall be paid to participants if, during the period between the date of a change in control and the next award date determined pursuant to Section 10:\n1) the participant's employment is terminated involuntarily other than for good cause, or\n2) the Plan is terminated.\nThe amount of the award shall be calculated as a percentage of period earnings based upon standard performance and prorated through the date of termination of the participant or the Plan, as applicable.\nA change of control of the Company is defined as follows:\nA. The acquisition by any individual, entity or group (within the meaning of Section 13 (d) (3) or 14 (d) (2) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\")) (a \"Person\") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the \"Outstanding Company Common Stock\") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the \"Outstanding Company Voting Securities\"); provided, however, that the following acquisitions shall not constitute a Change of Control: (i) any acquisition directly from the Company (excluding an acquisition by virtue of the exercise of a conversion privilege unless the security being so converted was itself acquired directly from the Company), (ii) any acquisition by the Company, (iii) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (iv) any acquisition by any corporation pursuant to a reorganization, merger or consolidation, if, following such reorganization, merger or consolidation, the conditions described in clauses (i), (ii) and (iii) of paragraph C of this Section 7.0 are satisfied; or\nB. Individuals who, as of the date hereof, constitute the Board of Directors of the Company (the \"Board\" and, as of the date hereof, the \"Incumbent Board\") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act) or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or\nC. Approval by the shareholders of the Company of a reorganization, merger, binding share exchange or consolidation, in each case, unless, following such reorganization, merger, binding share exchange or consolidation, (i) more than 60% of, respectively, the then outstanding shares of common stock of the corporation resulting from such reorganization, merger, binding share exchange or consolidation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such reorganization, merger, binding share exchange or consolidation in substantially the same proportions as their ownership, immediately prior to such reorganization, merger, binding share exchange or consolidation, of the Outstanding Company Stock and Outstanding Company Voting Securities, as the case may be, (ii) no Person (excluding the Company, any employee benefit plan (or related trust) of the Company or such corporation resulting from such reorganization, merger, binding share exchange or consolidation and any Person beneficially owning, immediately prior to such reorganization, merger, binding share exchange or consolidation, directly or indirectly, 20% or more of the Outstanding Company Stock or Outstanding Company Voting Securities, as the case may be) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such reorganization, merger, binding share exchange or consolidation or the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors and (iii) at least a majority of the members of the board of directors of the corporation resulting from such reorganization, merger, binding share exchange or consolidation were members of the Incumbent Board at the time of the execution of the initial agreement providing for such reorganization, merger, binding share exchange or consolidation; or\nD. Approval by the shareholders of the Company of (i) a complete liquidation or dissolution of the Company or (ii) the sale or other disposition of all or substantially all of the assets of the Company, other than to a corporation, with respect to which following such sale or other disposition, (a) more than 60% of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors is then beneficially owned, directly or indirectly, by all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such sale or other disposition in substantially the same proportion as their ownership, immediately prior to such sale or other disposition, of the same Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (b) no Person (excluding the Company and any employee benefit plan (or related trust) of the Company or such corporation and any Person beneficially owning, immediately prior to such sale or other disposition, directly or indirectly, 20% or more of the Outstanding Company Common Stock or Outstanding Company Voting Securities, as the case may be) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of such corporation and the combined voting power of the then outstanding voting securities of such corporation entitled to vote generally in the election of directors and (c) at least a majority of the members of the board of directors of such corporation were members of the Incumbent Board at the time of the execution of the initial agreement or action of the Board providing for such sale or other disposition of assets of the Company.\n7.5 Participants who leave the company or are terminated prior to the actual payment of award for reasons other than retirement, death, disability, termination in the fourth quarter due to a restructuring which results in job elimination, change in control, will forfeit the award for that plan year.\n8.0 INCENTIVE AWARDS THROUGH CONTRACTUAL AGREEMENTS\nIncentive awards may be made to participants who do not meet the six month eligibility requirements only if the following conditions are met.\n(1) Award must be made through contractual agreement made upon hiring, re-assignment, or commencement of special project or assignment. These arrangements must be approved in writing by Division President, Corporate Compensation, Corporate V.P. Human Resources, and normal 1 over 1 approval matrix.\n9.0 ADMINISTRATION OF THE PLAN\nThe Committee On Management of the Board of Directors reserves the right to interpret, amend, modify or terminate the existing program in accordance with changing conditions. Further, no participant eligible to receive any payments shall have any rights to pledge, assign, or otherwise dispose of unpaid portion of such payments. The Committee On Management is responsible for overall administration of the Plan. It will determine who will receive incentives and the amount of each incentive. It may also review the standards and objectives for a particular year. The Committee On Management may change or terminate the Plan at any time and no person has any rights with respect to an incentive award until it has been paid.\n10.0 INCENTIVE AWARD DISTRIBUTION\nIncentive awards, when payable, shall be paid in the latter part of the month of February following the close of the preceding fiscal year.\nParticipants may also elect to defer all or part of an incentive award in accordance with the procedure set forth in the Company's Deferred Compensation Plan.\nEXHIBIT (10)-h\nLONG TERM PERFORMANCE STOCK PLAN - I\nI. PURPOSE\nThe Long Term Performance Stock Plan - I (the \"Plan\") is designed to advance the interests of Bausch & Lomb Incorporated (the \"Company\") and its shareholders by (i) providing incentives for those key executives who have overall responsibility for the long term performance of the Company; (ii) reinforcing corporate long term financial goals; (iii) providing competitive levels of long term compensation for key executives; and (iv) aligning management and shareholder interests.\nII. ELIGIBILITY\nParticipation in the Plan is limited to senior officers with overall responsibility for the long term performance of the Company. The Committee on Management of the Board of Directors (the \"Committee\") will designate executives to participate in the Plan (\"Participants\").\nIII. AWARD CYCLES\nAward cycles (\"Award Cycles\") will be measured over three year periods, with the performance award, if any, for each Award Cycle to be paid early in the fourth year. There will be a series of overlapping Award cycles with a new Award Cycle starting and an old Award Cycle finishing each year.\nIV. PERFORMANCE GOALS\nThe chief executive officer of the Company, with approval of the Committee, will establish the performance goals for each Award Cycle, ensuring that the goals are equitable and compatible with the Company's major business objectives. The performance goals for each Award Cycle will be based upon a matrix of sales growth and return on equity (\"ROE\") for the Company.\nV. AWARDS\nIf the performance goals of the Company are achieved for an Award Cycle, Participants in the Plan will be eligible for awards which are calculated using an adjusted salary midpoint equal to the Participant's salary midpoint in effect in the first year of the Award Cycle multiplied times 110% (\"Adjusted Salary Midpoint\"). The Adjusted Salary Midpoint is then multiplied by 50% to calculate the standard award (\"Standard Award\") for each salary grade. If a Participant's salary grade changes in the course of an Award Cycle, the Participant's Standard Award will be adjusted using the Adjusted Salary Midpoint for the new grade level which was in effect during the first year of that Award Cycle.\nDepending upon the level of performance achieved by the Company, the amount of a Participant's actual award will range from 50% to 200% of the Standard Award (the \"Award\"). Awards paid pursuant to this Plan will consist of cash and Bausch & Lomb Class B Stock granted pursuant to the 1990 Stock Incentive Plan or any successor plan (the \"Stock Plan\").\nVI. PERFORMANCE UNITS\nAt the February meeting of the Committee following the commencement of the Award Cycle, each Participant will receive performance units (\"Performance Units\") equal to the number of shares of Class B Stock which, as of the date of such meeting of the Committee, have an aggregate fair market value (as determined under the Stock Plan) equal to 50% of each Participant's Standard Award. During the Award Cycle, Participants will receive quarterly cash payments on their Performance Units equal to the dividends which would be payable on a like number of shares of Class B Stock. Participant's Standard Award calculation changes because of a salary grade change in the course of an Award Cycle, the number of Performance Units will be adjusted accordingly.\nVII. PAYOUTS\nAt the end of each Award Cycle, the Standard Award will be adjusted by the Committee to reflect sales growth and ROE performance on the applicable payout matrix to determine the amount of the Award payable to each Participant. The Award payable to a Participant may also be modified by the Committee if the Award does not accurately reflect performance due to general economic conditions, industry changes, corporate strategy changes, natural disasters or any similar condition. One half of that amount shall be paid in cash. The Participant will also receive shares of Class B Stock(pursuant to the Stock Plan) equal to the number of Performance Units granted to the Participant; provided, however, that if the Award is based upon a percentage which is more than or less than 100% of the Standard Award, the number of shares of Class B Stock to be granted will be adjusted up or down by a like percentage. There will be no adjustments in the number of shares of Class B Stock for fluctuations up or down in the fair market value of Class B Stock from the date of grant of Performance Units at the beginning of the Award Cycle to the date of grant of the Class B Stock, if any, after the Award Cycle. Notwithstanding any other provision of this Plan, if a Participant's performance results in calculation of an Award which would be less than 50% of the Standard Award, the Participant will nonetheless be entitled to a minimum grant of Class B Stock equal to 50% of the Performance Units granted to the Participant.\nWhether or not an Award is paid for an Award Cycle, all Performance Units granted hereunder for an Award Cycle shall expire at the end of the Award Cycle, and Participants shall have no further rights with respect to such Units, except to the extent that their performance entitles them to an Award. Performance Units shall not give Participants any rights under the Stock Plan maintained by the Company.\nVIII. DEFERRAL\nAny or all of the cash portion of an Award may be deferred, at the option of the Participant, into the Company's Deferred Compensation Plan. Notice of such a deferral must be given to the Company at least 18 months prior to the end of each Award Cycle for which deferral is requested.\nIX. TERMINATION OF EMPLOYMENT\nIf the Participant's employment with the Company terminates before the end of any Award Cycle due to death, disability, or retirement, the Participant or his/her beneficiary is entitled to a pro rata share of any Award paid at the end of the Award Cycle, unless the Committee, upon the recommendation of the Chief Executive Officer, decides that a prorated Award should be paid prior to the end of the Award Cycle. If the Participant's employment with the Company terminates before the end of any Award Cycle for any other reason, the Participant's Performance Units shall be forfeited and the Participant shall not be entitled to any Award hereunder.\nX. ADMINISTRATION OF THE PLAN\nThe Committee is responsible for the overall administration of the Plan. The Committee will, by formal resolution: 1) approve the Performance Goals for the Award Cycle at the beginning of each Award Cycle; 2) set new or adjust previously set performance goals as appropriate to reflect major unforeseen events; and 3) administer the Plan in all respects to carry out its purposes and objectives including, but not limited to, responding to changes in tax laws, regulations or rulings, changes in accounting principles or practices, mergers, acquisitions or divestitures, major technical innovations, or extraordinary, nonrecurring, or unusual items, to preserve the integrity of the Plan's objectives. The Committee reserves the right, in its discretion, to pay any Awards hereunder entirely in cash. The effective date of each Award Cycle is January 1 of the first year of the performance period.\nXI. RECAPITALIZATION\nIn the event there is any recapitalization in the form of a stock dividend, distribution, split, subdivision or combination of shares of common stock of the Company, resulting in an increase or decrease in the number of common shares outstanding, the number of Performance Units then granted under the Plan shall be increased or decreased proportionately, as the case may be.\nXII. REORGANIZATION\nIf, pursuant to any reorganization, sale or exchange of assets, consolidation or merger, outstanding Class B Stock is or would be exchanged for other securities of the Company or of another company which is a party to such transaction, or for property, any grant of Performance Units under the Plan theretofore granted shall, subject to the provisions of this Plan for making Awards, apply to the securities or property into which the Class B Stock covered thereby would have been changed or for which such Class B Stock would have been exchanged had such Class B Stock been outstanding at the time. EXHIBIT (10)-i\nLONG TERM PERFORMANCE STOCK PLAN - II\nI. PURPOSE The Long Term Performance Stock Plan - II (the \"Plan\") is designed to advance the interests of Bausch & Lomb Incorporated (the \"Company\") and its shareholders by (i) providing incentives for those key executives who have a major impact on long term corporate performance; (ii) reinforcing corporate long term financial goals; (iii) providing competitive levels of long term compensation for key executives; and (iv) aligning management and shareholder interests.\nII. ELIGIBILITY Participation in the Plan is limited to officers and other selected key executives who have a major impact on the performance of the Company. The Company's chief executive officer or his designees will designate executives to participate in the Plan (\"Participants\").\nIII. AWARD CYCLES Award cycles (\"Award Cycles\") will be measured over three year periods, with the performance award, if any, for each Award Cycle to be paid early in the fourth year. Award Cycles will commence on January 1 of the first year of each performance period.\nIV. PERFORMANCE GOALS The chief executive officer or his designees will establish the performance goals for each Award Cycle, ensuring that the goals are equitable and are compatible with the Company's major business objectives. The performance goals for each Participant will relate to the Participant's area of responsibility and be consistent with the long term goals of the Company. For Participants who are part of the Company's corporate staff, their performance goals will be weighted twothirds based upon the Participant's individual goals and onethird based upon the corporate wide financial goals of return on equity and sales growth. The corporate wide goals will be established by the chief executive officer or his designees.\nV. AWARDS A. Officer Awards If a Participant who is an officer achieves his or her performance goals for an Award Cycle, such Participant will be eligible for an award which is calculated using an adjusted salary midpoint equal to the Participant's salary midpoint in effect in the first year of the Award Cycle multiplied times 110% (\"Adjusted Salary Midpoint\"). The Adjusted Salary Midpoint is then multiplied by the appropriate percentage set forth below to calculate the three year standard award (\"Standard Award\") for each salary grade:\nB. Non Officer Awards. If a Participant who is not an officer achieves his or her performance goals for an Award Cycle, such Participant will be eligible for an award which is calculated using the Participant's salary in effect in the first year of the Award Cycle multiplied times 110% (\"Adjusted Salary\"). The Adjusted Salary is then multiplied by 45% to calculate the Standard Award for a non-officer Participant.\nC. Adjustments to Award Calculation If an officer Participant's salary grade changes in the course of an Award Cycle, such Participant's Standard Award will be adjusted using the Adjusted Salary Midpoint for the new grade level which was in effect during the first year of that Award Cycle. For all non-officer Participants, the calculation of the Standard Award will be adjusted using each such Participant's actual salary in the third year of the Award Cycle.\nD. Award Amount Depending upon the level of performance achieved by each Participant, the amount of a Participant's actual award, if any, will range from 50% to 200% of the Standard Award as adjusted pursuant to Section V.C. above (the \"Award\"). Awards paid pursuant to this Plan will consist of cash and Bausch & Lomb Class B Stock granted pursuant to the 1990 Stock Incentive Plan or any successor plan (the \"Stock Plan\"). If a Participant's performance results in calculation of an Award which would be less than 50% of the Standard Award, the Participant will nonetheless be entitled to a minimum grant of Class B Stock equal to 50% of the Performance Units granted to the Participant pursuant to Section VI below.\nVI. PERFORMANCE UNITS\nIn February following the commencement of an Award Cycle each Participant will receive performance units (\"Performance Units\") equal to the number of shares of Class B Stock which, as of the date of the February meeting of the Committee on Management of the Board of Directors (the \"Committee\"), have an aggregate fair market value (as determined under the Stock Plan) equal to 50% of each Participant's Standard Award. During the Award Cycle, Participants will receive quarterly cash payments on their Performance Units equal to the dividends which would be payable on a like number of shares of Class B Stock. If an officer Participant's Standard Award calculation changes because of a salary grade change due to a promotion in the course of an Award Cycle, the number of Performance Units will be adjusted accordingly at the end of the Award Cycle. For non-officer Participants the number of Performance Units will be adjusted at the end of the third year of the Award Cycle when the non-officer Participant's Standard Award is adjusted for actual salary increases pursuant to Section V.C. above.\nVII. PAYOUTS\nAt the end of each Award Cycle, the Standard Award (as adjusted pursuant to Section V.C. above) will be modified by the chief executive officer or his designees to reflect performance against the applicable goals and determine the amount of the Award payable to each Participant. The Award payable to a Participant may also be modified by the chief executive officer or his designees if the Award does not accurately reflect performance due to general economic conditions, industry changes, corporate strategy changes, natural disasters or any similar condition. One half of the Award amount shall be paid in cash. The Participant will also receive shares of Class B Stock (pursuant to the Stock Plan) equal to the number of Performance Units granted to the Participant; provided, however, that if the Award is based upon a percentage which is more than or less than 100% of the Standard Award, the number of shares of Class B Stock to be granted will be adjusted up or down by a like percentage. There will be no adjustments in the number of shares of Class B Stock for fluctuations up or down in the fair market value of Class B Stock from the date of grant of Performance Units at the beginning of the Award Cycle to the date of grant of the Class B Stock, if any, after the Award Cycle.\nWhether or not an Award is paid for an Award Cycle, all Performance Units granted hereunder for an Award Cycle shall expire immediately after the Award Cycle, and Participants shall have no further rights with respect to such Units, except to the extent that their performance entitles them to an Award. Performance Units shall not give Participants any rights under the Stock Plan.\nVIII. DEFERRAL Any or all of the cash portion of an Award may be deferred, at the option of the Participant, into the Company's Deferred Compensation Plan. Notice of such a deferral must be given to the Company at least 18 months prior to the end of each Award Cycle for which deferral is requested.\nIX. TERMINATION OF EMPLOYMENT If the Participant's employment with the Company terminates before the end of any Award Cycle due to death, disability, or retirement, the Participant or his/her beneficiary is entitled to a pro rata share of any Award paid at the end of the Award Cycle, unless the chief executive officer or his designees decide that a pro rated Award should be paid prior to the end of the Award Cycle. If the Participant's employment with the Company terminates before the end of any Award Cycle for any other reason, the Participant's Performance Units shall be forfeited and the Participant shall not be entitled to any Award hereunder.\nX. ADMINISTRATION OF THE PLAN This Plan has been adopted by the Committee, and the Committee may amend, suspend or terminate the Plan or any portion thereof at any time. The Committee is responsible for the design of the Plan and the overall administration of the Plan. Notwithstanding any other provision of this Plan, all grants of Class B Stock made in connection with this Plan shall be subject to the discretion of the Committee which shall make any such grants pursuant to the Stock Plan. The Committee reserves the right, in its discretion, to pay any Awards hereunder entirely in cash.\nThe chief executive officer or his designees will: 1) approve the Performance Goals for each Award Cycle at the beginning of the Award Cycle; 2) set new or adjust previously set performance goals or terminate current Award Cycles and commence new Award Cycles for individual Participants as appropriate to reflect major unforeseen events which are negatively affecting performance; and 3) administer the Plan to carry out its purposes and objectives such as, but not limited to, responding to changes in tax laws, regulations or rulings, changes in accounting principles or practices, mergers, acquisitions or divestitures, major technical innovations, or extraordinary, non-recurring, or unusual items, to preserve the integrity of the Plan's objectives.\nXI. RECAPITALIZATION In the event there is any recapitalization in the form of a stock dividend, distribution, split, subdivision or combination of shares of common stock of the Company, resulting in an increase or decrease in the number of common shares outstanding, the number of Performance Units then granted under the Plan shall be increased or decreased proportionately, as the case may be.\nXII. REORGANIZATION If, pursuant to any reorganization, sale or exchange of assets, consolidation or merger, outstanding Class B Stock is or could be exchanged for other securities of the Company or of another company which is a party to such transaction, or for property, any grant of Performance Units under the Program theretofore granted shall, subject to the provisions of this Program for making Awards, apply to the securities or property into which the Class B Stock covered thereby would have been changed or for which such Class B Stock would have been exchanged had such Class B Stock been outstanding at the time.\nEXHIBIT 22\nEXHIBIT (24)\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of Bausch & Lomb Incorporated\nout audits of the consolidated financial statements referred to in our report dated January 25, 1994 appearing on page 63 of the 1993 Annual Report to Shareholders of Bausch & Lomb Incorporated (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedules listed in Item 14(a)2, of this Form 10-K. In our opinion, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n/s/ Price Waterhouse\nPRICE WATERHOUSE\nRochester, New York January 25, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 2-56066, 2-85158, 33- 15439 and 33-35667) and in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 3351117) of Bausch & Lomb Incorporated of our report dated January 25, 1994 appearing on page 63 of the 1993 Annual Report to Shareholders of Bausch & Lomb Incorporated which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our above report on the Financial Statement Schedules.\n/s/ Price Waterhouse\nPRICE WATERHOUSE\nRochester, New York March 23, 1994 EXHIBIT (25)\nPOWER OF ATTORNEY\nThe undersigned directors of Bausch & Lomb Incorporated (the \"Company\"), each hereby constitutes and appoints Daniel E. Gill and Jay T. Holmes, or either of them, his or her respective true and lawful attorneys and agents, each with full power and authority to act as such without the other, to sign for and on behalf of the undersigned the Company's Annual Report on Form 10-K for the year ended December 25, 1993, to be filed with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934 and the related rules and regulations thereunder, and any amendment or amendments thereto, the undersigned hereby ratifying and confirming all that said attorneys and agents, or either one of them, shall do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, this instrument has been executed by the undersigned as of this 22 day of March, 1994.\n/s/ Franklin E. Agnew /s/ Linda Johnson Rice Franklin E. Agnew Linda Johnson Rice\n/s/ William Balderson III /s/ Robert L. Tarnow William Balderston III Robert L. Tarnow\n/s/ Bradford R. Boss /s/ Alvin W. Trivelpiece Bradford R. Boss Alvin W. Trivelpiece\n/s/ Daniel E. Gill /s/ William H. Waltrip Daniel E. Gill William H. Waltrip\n/s/ Jay T. Holmes /s/ Kenneth L. Wolfe Jay T. Holmes Kenneth L. Wolfe\n/s/ Ruth R. McMullin /s/ Ronald L. Zarrella Ruth R. McMullin Ronald L. Zarrella\nJohn R. Purcell"},"word_count":{"kind":"number","value":11175,"string":"11,175"},"character_count":{"kind":"number","value":71798,"string":"71,798"}}},{"rowIdx":298,"cells":{"filename":{"kind":"string","value":"63276_1993.txt"},"id":{"kind":"string","value":"63276_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"63276"},"text":{"kind":"string","value":"Item 1. Business - ------- --------\nThe Company designs, develops, manufactures, markets and distributes a broad variety of toy products on a worldwide basis. Measured by revenues, the Company is the second largest toy company in the world. The Company's three strongest principal product lines are BARBIE fashion dolls and doll clothing and accessories, FISHER-PRICE toys and juvenile products and the Company's Disney- licensed toys, each of which has broad worldwide appeal. Additional current principal product lines consist of die-cast vehicles and accessories, including HOT WHEELS; large dolls; preschool toys, including SEE 'N SAY talking toys; and the UNO and SKIP-BO games. Revenues for 1993 of $2.7 billion were a record level for the Company.\nIn November 1993, Fisher-Price, Inc. (\"Fisher-Price\") became a wholly- owned subsidiary of Mattel as a result of a merger transaction (the \"Fisher- Price Merger\"). See Note 2 to the Consolidated Financial Statements in the Annual Report to Shareholders for the year ended December 31, 1993 (the \"Annual Report to Shareholders\"), incorporated herein by reference and Item 4 \"Submission of Matters to a Vote of Security Holders\" below. As used herein, unless the context requires otherwise, \"Mattel\" refers to Mattel, Inc., and its subsidiaries other than Fisher-Price, and the \"Company\" refers to Mattel together with Fisher-Price.\nMattel was incorporated in California in 1948 and reincorporated in Delaware in 1968. Its executive offices are located at 333 Continental Boulevard, El Segundo, California 90245-5012, telephone (310) 524-2000.\nCompetition and Industry Background - -----------------------------------\nCompetition in the toy industry is based primarily on price, quality and play value. In recent years, the toy industry has experienced rapid consolidation driven, in part, by the desire of industry competitors to offer a range of products across a broader variety of categories. In the United States, the Company competes with several large toy companies, including Hasbro, Inc. and Tyco Toys, Inc. as well as a number of smaller toy companies. The larger toy companies have pursued a strategy of focusing on core product lines. Core product lines are lines which are expected to be marketed for an extended period of time, and which historically have provided relatively consistent growth in sales and profitability. By focusing on core product lines, toy manufacturers have been able to reduce their reliance on new product introductions and the associated risk and volatility. The juvenile products market, in which Fisher-Price is one of the leading companies, is more fragmented. The more significant competitors in this area include Gerry Baby Products Company, Century Products Company, Graco Children's Products, Inc., Cosco, Inc. and Evenflo Juvenile Furniture Company, Inc.\nThe toy industry is also experiencing a shift toward greater consolidation of retail distribution channels, such as large specialty toy stores and discount retailers, including Toys R Us, Wal-Mart, Kmart and Target, which have increased their overall share of the retail market. This consolidation has resulted in an increasing reliance among retailers on the large toy companies because of their financial stability and their ability to support products through advertising and promotion and to distribute products on a national basis. These retailers' growing acceptance of electronic data interchange has provided toy manufacturers with an ability to more closely monitor consumers' acceptance of a particular product or product line.\nOver the last ten years, toy companies based in the United States have expanded their international marketing and manufacturing operations. The Company believes a strong international distribution system can add significantly to the sales volume of core product lines and extend the life cycles of newly-developed products.\nSeasonality - -----------\nSales of toy products at retail are seasonal, with a majority of retail sales occurring during the period from September through December. Consequently, shipments of toy products to retailers are greater in the third and fourth quarters than in each of the first and second quarters. As the large toy retailers become more efficient in their control of inventory levels, this seasonality is likely to increase.\nIn anticipation of this seasonal increase in retail sales, the Company significantly increases its production in advance of the peak selling period, resulting in a seasonal build-up of inventory levels. In addition, the Company and others in the industry develop sales programs, including offering extended payment terms, to encourage retailers to purchase merchandise earlier in the year. These sales programs, coupled with seasonal shipping patterns, result in significant peaks in the third and fourth quarters in the respective levels of inventories and accounts receivable, which contribute to a seasonal working capital financing requirement. See \"Seasonal Financing.\"\nProducts - --------\nThe Company has been able to record consistent sales and earnings growth by focusing on a number of core product lines supplemented by various new product introductions. The Company's three strongest core product lines are BARBIE fashion dolls and doll clothing and accessories, FISHER-PRICE toys and juvenile products, and the Company's Disney-licensed toys, each of which has broad worldwide appeal. Additional current core product lines consist of die-cast vehicles and accessories, including HOT WHEELS; large dolls; preschool toys, including SEE 'N SAY talking toys; and the UNO and SKIP-BO games. Core product lines are expected to be marketed for an extended period of time and historically have provided relatively consistent growth in sales and\nprofitability. For the year ended December 31, 1993, core products accounted for approximately 86% of sales. In order to provide greater flexibility in the manufacture and delivery of products, and as part of a continuing effort to reduce manufacturing costs, the Company has concentrated production of most of its core products in Company-owned facilities and generally uses independent contractors for the production of non-core products.\nWith respect to new product introductions, the Company's strategy is to begin production on a limited basis until a product's initial success has been proven in the marketplace. The production schedule is then modified to meet anticipated demand. The Company further limits its risk by generally having independent contractors manufacture new product lines in order to minimize capital expenditures associated with new product introductions. This strategy has reduced inventory risk and significantly limited the potential loss associated with new product introductions.\nNew product introductions in 1993 included the HOLLYWOOD HAIR BARBIE doll and the MY SIZE BARBIE doll, the addition of a series of dolls based on the animated feature \"Snow White and the Seven Dwarfs\" to the Company's Disney line, the BABY WALK 'N ROLL and SALLY SECRETS large dolls and the addition of the ATTACK PACK line of monster trucks to the Company's HOT WHEELS line. The Company also introduced a line of activity toys called McDONALD'S HAPPY MEAL MAGIC.\nNew product introductions in 1994 will include the Gymnast BARBIE, Bedtime BARBIE and DR. BARBIE dolls; Fisher-Price's new plush RUMPLE BEARS, TRIPLE ARCADE electronic game, and electronic learning toys; the additions of COLOR FX and HOT WHEELS TOP SPEED PIPEJAMMER vehicles to the HOT WHEELS line; and the addition to the Company's Disney line of a series of plush products, action figures and small dolls based on the animated feature \"The Lion King\". The Company also will introduce a new line of large dolls called DREAMLAND Babies, and Nickelodeon THINGMAKER, a new activity toy. In conjunction with the release of the feature film \"The Flintstones,\" the Company will introduce a line of small dolls, large dolls, action figures and accessories.\nInternational Operations - ------------------------\nRevenues from the Company's international operations represented approximately 40% of total consolidated revenues in 1993. Products which are developed and marketed successfully in the United States typically generate incremental sales and profitability when marketed through the Company's international distribution network. Generally, products marketed internationally are the same as those marketed domestically, although some are developed or adapted for particular international markets. The Company sells its products directly through its wholly-owned subsidiaries in Australia, Austria, the Benelux countries, Canada, Chile, France, Germany, Greece, Italy, Japan, Mexico, Scandinavia, Spain, Switzerland, the United Kingdom and in certain areas of Eastern Europe and Asia. In 1994, the Company will begin selling its products directly in Argentina, Portugal and Venezuela\nthrough newly established subsidiaries. In addition to direct sales, the Company sells principally through distributors in Central and South America, the Middle East, South Africa and Southeast Asia. It also licenses some of its products to other toy companies for sale in various other countries. Until December 1993, Mattel also distributed the Nintendo Entertainment System and related products in Australia. See \"Licenses and Distribution Agreements.\"\nThe strength of the U.S. dollar relative to other currencies can significantly affect the revenues and profitability of the Company's international operations. The Company hedges intercompany purchases and sales of inventory in order to protect local cash flows and profitability from currency fluctuations. See \"Foreign Currency Contracts.\" For financial information by geographic area, see Note 8 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nProduct Design and Development - ------------------------------\nThrough its product design and development group, the Company regularly refreshes, redesigns and extends existing product lines and develops innovative new product lines. The Company's success is dependent on its ability to continue this activity. Product design and development are principally conducted by a group of professional designers and engineers employed by the Company.\nLicense agreements with third parties permit the Company to utilize the name, character or product of the licensor in its product line. A principal licensor is The Walt Disney Company, which licenses many of its characters for use on the Company's products. The Company also has entered into license agreements with, among others, McDonald's, Inc., MCA Universal Merchandising, Inc., the Time Warner Entertainment Company, L.P. and DC Comics, Inc. units of Time Warner Inc., LucasArts Entertainment Company, Turner Home Entertainment, Inc., Hanna-Barbera Productions, Inc., American Greeting Cards, Inc., Children's Television Workshop, and Viacom International, Inc. relating to its Nickelodeon properties. A number of these licenses relate to product lines that are significant to the Company.\nIndependent toy designers and developers bring products to the Company and are generally paid a royalty on the net sales price of products licensed by the Company. These independent toy designers may also create different products for other toy companies.\nThe Company devotes substantial resources to product design and development. During the years ended December 31, 1993, December 31, 1992 and December 31, 1991, the Company expended approximately $75 million, $77 million and $56 million, respectively, in connection with the design and development of products, exclusive of royalty payments.\nAdvertising and Promotion - -------------------------\nThe Company supports its product lines with extensive advertising and consumer promotions. Advertising continues at varying levels throughout the year and peaks during the Christmas season. Advertising includes television and radio commercials and magazine and newspaper ads. Promotions include in-store displays, coupons, merchandising materials and major events focusing on products and tie-ins with various consumer product companies. To further promote the Company and its products, the Company participates in the attractions \"It's A Small World\" at Disneyland and Disney World and \"Autopia\" at Euro Disneyland under a ten-year agreement with The Walt Disney Company. The Company also participates in toy stores in Disneyland and in the Disney Village Market Place near Disney World and commenced participation in a new toy store in Euro Disneyland in December 1993. Separately, the Company has established a total of six BARBIE Boutiques in F.A.O. Schwarz toy stores, including the \"BARBIE on Madison\" boutique at the F.A.O. Schwarz flagship store in New York City.\nDuring the years ended December 31, 1993, December 31, 1992 and December 31, 1991, Mattel spent approximately $427 million (16% of net sales), $403 million (16% of net sales) and $308 million (15% of net sales), respectively, on worldwide advertising and promotion.\nMarketing and Sales - -------------------\nThe Company's toy products are sold throughout the world. In the United States, the Company's products are distributed directly to large retailers, including discount and free-standing toy stores, chain stores and department stores, and other retail outlets and, to a limited extent, to wholesalers. Discount and free-standing toy stores continue to increase their market share. During the year ended December 31, 1993, Toys R Us and Wal-Mart accounted for approximately 22% and 10%, respectively, of worldwide consolidated net sales and were the only customers accounting for 10% or more of consolidated net sales.\nIn general, the Company's major domestic and international customers review its product lines and product concepts for the upcoming year at showings beginning in late summer. The Company also participates in the domestic and international toy industry trade fairs in the first quarter of the year. A majority of the full-year orders are received by May 1. As is traditional in the toy industry, these orders may be canceled at any time before they are shipped. Historically, the greater proportion of shipments of products to retailers occurs during the third and fourth quarters of the year. See \"Seasonality.\"\nThrough its marketing research department, the Company conducts basic consumer research and product testing and monitors demographic factors and trends. This information assists the Company in evaluating consumer acceptance of products, including an analysis of increasing or decreasing demand for its products.\nThe Company bases its production schedules on customer orders, modified by historical trends, results of market research and current market information. The actual\nshipments of products ordered and the order cancellation rate are affected by consumer acceptance of the product line, the strength of competing products, marketing strategies of retailers and overall economic conditions. Unexpected changes in these factors can result in a lack of product availability or excess inventory in a particular product line.\nManufacturing - -------------\nThe Company's products are manufactured in Company facilities and by independent contractors. Products are also purchased from unrelated entities that design, develop and manufacture the products. In order to provide greater flexibility in the manufacture and delivery of products, and as part of a continuing effort to reduce manufacturing costs, the Company has concentrated production of most of its core products in the Company's facilities and generally uses independent contractors for the production of non-core products.\nAs a result of the Fisher-Price Merger, Mattel acquired manufacturing facilities in the states of Kentucky and New York, and in England and Mexico, which are in addition to its existing manufacturing facilities in the Far East (China, Indonesia and Malaysia), Mexico and Italy. The Company also utilizes independent contractors to manufacture products in the United States, the Far East and Australia. To protect the stability of its product supply, the Company produces many of its key products in more than one facility.\nForeign countries in which the Company's products are manufactured (principally China, Indonesia, Malaysia and Mexico) currently enjoy \"most favored nation\" (\"MFN\") status under U.S. tariff laws, which provides the most favorable category of U.S. import duties. As a result of conditions in China, there has been, and may be in the future, opposition to the extension of MFN status for China. In May 1993, President Clinton signed an executive order extending MFN status for China through June 3, 1994.\nThe loss of MFN status for China would result in a substantial increase in the import duty for toys manufactured in China and imported into the United States and would result in increased costs for the Company and others in the toy industry. The impact of such an event on the Company would be significantly mitigated by the Company's ability to source product for the U.S. market from countries other than China and ship product manufactured in China elsewhere. Toward that end, the Company has extended its production capacity in other countries. In addition, all of the manufacturing facilities gained by the Company in the Fisher-Price Merger are outside of China, although some Fisher-Price product is sourced in China. A number of other factors, including the Company's ability to pass along the added costs through price increases and the pricing policies of vendors in China, could further mitigate the impact of a loss of China's MFN status.\nOn February 8, 1994, the European Union (\"EU\") adopted quotas on the importation of certain classes of toys (as well as other products) manufactured in China, although regulations implementing the quotas have yet to be promulgated. The Company expects that the impact of these quotas on its business will be significantly mitigated by shifts in demand in favor of toy categories not subject to the quotas, and by the ability of the Company to source product for the EU from countries other than China and ship product manufactured in China elsewhere. The Company does not currently expect that these quotas will have a material effect on its business.\nCommitments - -----------\nIn the normal course of business, the Company enters into contractual arrangements for future purchases of goods and services to ensure availability and timely delivery, and to obtain and protect the right to create and market certain toys. Such arrangements include commitments for future inventory purchases and royalty payments pursuant to licensing agreements. Certain of these purchase agreements and licenses contain provisions for guaranteed or minimum payments during the terms of the contracts and licenses. See \"Management's Discussion and Analysis of Results of Operations and Financial Condition--Commitments\" and Note 7 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nLicenses and Distribution Agreements - ------------------------------------\nThe Company's level of licensing activity has expanded in recent years. Royalties paid to licensors during the years ended December 31, 1993, December 31, 1992 and December 31, 1991 were approximately $69 million, $50 million and $39 million, respectively.\nThe Company also distributes products which are independently designed and manufactured. The Company's agreement for the distribution of the Nintendo Entertainment System and related products in Australia was terminated in December 1993.\nForeign Currency Contracts - --------------------------\nFrom time to time, the Company enters into foreign currency forward exchange contracts, swaps and options as hedges of inventory purchases and sales and various other intercompany transactions. The contracts are intended to fix a portion of the Company's product cost and intercompany cash flows, and thereby moderate the impact of currency fluctuations. The Company does not speculate in foreign currencies.\nFor additional information regarding foreign currency contracts, see Note 7 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nSeasonal Financing - ------------------\nThe Company's financing of seasonal working capital typically grows throughout the first half of the year and peaks in the third or fourth quarter, when accounts receivable are at their highest due to increased sales volume and Company sales programs, and when inventories are at their highest in anticipation of expected second half sales volume. See \"Seasonality.\" Borrowings for seasonal financing are generally repaid in full by year-end from cash flows generated in the fourth quarter from sales and collection of accounts receivable.\nTo finance its working capital requirements, the Company maintains and periodically revises or replaces a revolving credit agreement with a commercial bank group. The agreement in effect during 1993, which was recently replaced (see below), was amended in the first quarter of 1993 to increase the total facility to $350 million from $250 millon and to release the banks' lien on Mattel's inventory and receivables. Within the total facility, up to $175.0 million was a standard revolving credit line available for either advances or letters of credit in support of commercial paper issuances. Interest was charged at alternative rates selected by Mattel not greater than the prime rate charged by the agent bank, plus a commitment fee of 3/8 of one percent of the unused line available for advances and 1/2 of one percent of the amount utilized for standby letters of credit. The remaining $175.0 million was available for nonrecourse purchases of certain trade accounts receivable of Mattel by the commercial bank group providing the credit line. The agreement required Mattel to comply with certain consolidated financial ratios and to maintain certain levels of income.\nIn 1993, the Company's domestic seasonal borrowings outstanding under the revolving credit agreement and other bank borrowings averaged approximately $45.1 million and reached a peak of approximately $167.0 million during the third quarter. This balance was fully repaid by December 31, 1993. The Company's 1993 seasonal borrowings outstanding under foreign credit lines averaged approximately $55.1 million, reached a peak of approximately $76.1 million in the third quarter, and were also fully repaid by year end.\nEffective in March 1994, the Company renegotiated its revolving credit agreement. The new agreement consists of unsecured facilities providing a total of $500.0 million in seasonal financing from the same group of commercial banks. The facilities provide for up to $250.0 million in advances and backup for commercial paper issuances ($125.0 million of which is a 364-day facility and the other $125.0 million is a 3-year facility), and up to an additional $250.0 million (a 3-year facility) for nonrecourse purchases of certain trade accounts receivable by the bank group. In connection with the agreement, the Company is to comply with certain consolidated financial covenants for debt-to-capital, interest coverage and tangible net worth levels.\nConcurrently with the consummation of the Fisher-Price Merger, the Fisher- Price domestic seasonal credit line was terminated with a view to financing Fisher- Price's domestic seasonal working capital needs under Mattel's revolving credit agreement. During 1994, the Company expects to finance Fisher-Price's foreign seasonal working capital needs under Mattel's seasonal credit facilities and to terminate Fisher-Price's foreign seasonal credit lines.\nBorrowings for seasonal financing were significantly reduced in 1993 primarily as a result of a higher level of cash at the beginning of the year, the issuance by the Company in May 1993 of $100 million aggregate principal amount of 6-3/4% Notes due 2000 and the utilization of the Company's accounts receivable sales facility.\nThe Company believes the amounts available to it under its revolving credit agreement and its foreign credit lines will be adequate to meet its seasonal financing requirements.\nRaw Materials - -------------\nPackaging materials, most plastics and zinc essential to the production and marketing of toy products are currently in adequate supply. These and other raw materials are generally available from a number of suppliers.\nTrademarks, Copyrights, and Patents - -----------------------------------\nMost of the Company's products are sold under trademarks, trade names and copyrights and a number of those products incorporate patented devices or designs. Trade names and trademarks are significant assets to the Company in that they provide product recognition and acceptance worldwide.\nThe Company customarily seeks patent, trademark or copyright protection covering its products, and it owns or has applications pending for United States and foreign patents covering many of its products. A number of these trademarks and copyrights relate to product lines that are significant to the Company and the Company believes its rights to these properties are adequately protected.\nThe Company also licenses various of its trademarks, characters and other property rights to others for use in connection with the sale by others of non-toy products and other products which do not compete with the Company's products.\nGovernment Regulations - ----------------------\nThe Company's toys are subject to the provisions of the Consumer Product Safety Act, the Federal Hazardous Substances Act and the Flammable Fabrics Act, and the regulations promulgated thereunder. The Consumer Product Safety Act and the Federal Hazardous Substances Act enable the Consumer Product Safety Commission (the \"CPSC\") to exclude from the market consumer products that fail to comply with applicable product safety regulations or otherwise create a substantial risk of injury, and articles that contain excessive amounts of a banned hazardous substance. The Flammable Fabrics Act enables the CPSC to regulate and enforce flammability standards for fabrics used in consumer products. The CPSC may also require the repurchase by the manufacturer of articles which are banned. Similar laws exist in some states and cities and in various international markets.\nFisher-Price's car seats are subject to the provisions of the National Highway Transportation Safety Act, which enables the National Highway Traffic Safety Administration (\"NHTSA\") to promulgate performance standards for child restraint systems. Fisher-Price conducts periodic tests to ensure that its child restraint systems meet applicable standards. A Canadian agency, Transport Canada, also regulates child restraint systems sold for use in Canada. As with the CPSC, NHTSA and Transport Canada can require the recall and repurchase or repair of products which do not meet their respective standards.\nThe Company maintains a quality control program to ensure product safety compliance with the various federal, state and international requirements.\nEffects of Inflation - --------------------\nInflation rates in the U.S. and major foreign countries in which the Company operates have not had a significant impact on operating results for the three years ended December 31, 1993. The U.S. Consumer Price Index increased 2.7% in 1993, 2.9% in 1992 and 3.1% in 1991. The Company is afforded some protection from the impact of inflation as a result of high turnover of inventories and benefitted from inflation on the repayment of fixed-rate liabilities during these periods.\nEmployees - ---------\nThe total number of persons employed by the Company and its subsidiaries at any one time varies because of the seasonal nature of its manufacturing operations. At December 31, 1993, the Company's total number of employees, including its international operations, was approximately 21,000.\nExecutive Officers of the Registrant - ------------------------------------\nThe executive officers of the Company, all of whom are appointed annually by the Board of Directors and serve at the pleasure of the Board, are as follows:\nMr. Amerman has been Chairman of the Board & Chief Executive Officer since February 1987 and a member of the Board of Directors since November 1985. Prior to that he served as President of Mattel International.\nMs. Barad has been President & Chief Operating Officer since August 1992 and a member of the Board of Directors since November 1991. From December 1989 until August 1992, she was President, Mattel USA. Prior to that she served in various executive positions in the Marketing, Product Design and Product Development areas.\nMr. Eskridge has been a member of the Board of Directors since February 1993 and President of Fisher-Price, Inc. since November 1993. Prior to that he was Executive Vice President & Chief Financial Officer of Mattel, Inc.\nMr. Gandolfo has been President, Mattel Operations, since April 1990. Prior to that he was General Manager of Manufacturing, Thompson Consumer Electronics.\nMr. Williams has been a member of the Board of Directors since November 1991 and has been President, Mattel International for more than five years.\nMr. McCafferty has been Executive Vice President & Chief Financial Officer since November 1993. From June 1993 to November 1993 and from November 1985 to October 1992 he was Senior Vice President & Treasurer. During the period from October 1992 to June 1993, he was Senior Vice President & Controller.\nMr. McKay has been Senior Vice President, Human Resources and Administration since November 1993. From December 1991 until November 1993 he was Vice President, Human Resources. He was Senior Director Human Resources from March 1991 to December 1991. Prior to that he was Vice President Human Resources-Administration of Mileage Plus, Inc.\nMr. Mansour has been Senior Vice President, General Counsel & Secretary since February 1993. From May 1992 until February 1993 he was Senior Vice President & General Counsel and from April 1991 until May 1992 he was Vice President & Associate General Counsel. Prior to that he was Vice President & Assistant General Counsel.\nMr. Rolfes has been Senior Vice President & Controller since November 1993. From June 1993 to November 1993 he was Vice President & Controller. Prior to that he held various executive positions within the finance department.\nMr. Stavro has been Vice President & Treasurer since November 1993. From March 1992 to November 1993 he was Vice President and Assistant Treasurer. Prior to that he was Assistant Treasurer for more than five years.\nItem 2.\n\n\nItem 2. Properties - ------- ----------\nThe Company owns its corporate headquarters consisting of approximately 335,000 square feet in El Segundo, California. The facility is subject to a $45 million mortgage. The Company also leases two buildings in El Segundo which consist of a total of approximately 250,000 square feet for its design and development and audio-visual departments.\nThe Company maintains sales offices in California, Illinois, New York and Texas and warehouse and distribution facilities in California and Texas. The Company owns a computer facility in Phoenix, Arizona. Internationally, the Company has offices and/or warehouse space in Argentina, Australia, Belgium, Canada, Chile, Denmark, France, Germany, Greece, Hong Kong and in certain other areas of Asia, Italy, Japan, The Netherlands, Spain, Switzerland and the United Kingdom. The Company's principal manufacturing facilities, including the Fisher-Price facilities, are located in China, Indonesia, Italy, Malaysia, Mexico, the United Kingdom and the United States. See \"Manufacturing.\"\nMost of the Company's facilities are occupied under long-term leases and, for the most part, are fully utilized, although excess manufacturing capacity exists from time to time based on product mix and demand. With respect to leases which are scheduled to expire during the next twelve months, the Company may negotiate new lease agreements, renew leases or utilize alternative facilities.\nAs a result of the Fisher-Price Merger, Mattel acquired the approximately 288,000 square foot Fisher-Price headquarters building and a second smaller office building in East Aurora, New York and manufacturing, distribution and warehousing facilities in Kentucky, New York, Tennessee, Belgium, Canada, Mexico and the United Kingdom. In addition, Fisher-Price owns or leases office and showroom space in New York, Texas, Belgium, Canada, Denmark, France, Germany, Hong Kong, Italy, Mexico and the United Kingdom. The Company is currently in the process of evaluating the desirability of maintaining certain of these facilities and expects to sell, sublease or not renew the leases of those facilities which are vacant, underutilized or redundant of Mattel facilities.\nItem 3.\nItem 3. Legal Proceedings - ------- -----------------\nThe Company's Fisher-Price subsidiary has executed a consent order with the State of New York involving a remedial action/feasibility study for voluntary cleanup of contamination at one of its manufacturing plants. The ultimate liability associated with this cleanup presently is estimated to be less than $850,000.\nThe Company is involved in various litigation and other legal matters which are being defended and handled in the ordinary course of business. None of these matters is expected to result in outcomes having a material adverse effect on the Company's liquidity, operating results or consolidated financial position.\nItem 4.\nItem 4. Submission of Matters to a Vote of Security Holders - ------ ---------------------------------------------------\nA Special Meeting of Stockholders of Mattel was held on November 30, 1993 to consider the three proposals described below. Proxies for the meeting were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, and there was no solicitation in opposition to that of management. Each of the proposals was approved based upon the respective tallies of votes set forth below.\nProposal 1: To approve the issuance of shares of Mattel common stock in connection with the Agreement and Plan of Merger, dated as of August 19, 1993, among Mattel, MAT Acquisition, Inc., a wholly-owned subsidiary of Mattel (\"Sub\"), and Fisher-Price pursuant to which (i) Sub was merged into Fisher-Price and Fisher-Price became a wholly-owned subsidiary of Mattel, and (ii) each outstanding share of Fisher-Price common stock (other than shares owned by Fisher-Price as treasury stock or by its subsidiaries or by Mattel or its subsidiaries, all of which were canceled), were converted into 1.275 shares of Mattel common stock, including the corresponding percentage of rights to purchase Mattel's Series E Junior Participating Preference Stock.\nVotes Cast Votes Cast Votes Broker For Against Abstaining Non-votes ---------- ---------- ---------- --------- 76,565,585 761,611 155,626 6,753,524\nProposal 2: To approve an amendment to the Amended & Restated Certificate of Incorporation of Mattel to increase the number of shares of common stock authorized to be issued from 150,000,000 to 300,000,000.\nVotes Cast Votes Cast Votes Broker For Against Abstaining Non-votes ---------- ---------- ---------- --------- 80,704,897 2,741,169 790,280 0\nProposal 3: To approve an amendment to the Mattel 1990 Stock Option Plan to increase, above the 1% limitation set forth in the plan, the amount of capital stock that may be the subject of awards granted wholly or partly in stock in 1993 by 3,000,000 shares of capital stock (with any such capital stock which is not the subject of awards in 1993 to be carried forward and available for awards in succeeding calendar years).\nVotes Cast Votes Cast Votes Broker For Against Abstaining Non-votes ---------- ---------- ---------- --------- 64,197,291 12,446,002 839,528 6,753,525\nPART II -------\nItem 5.\nItem 5. Market for the Registrant's Common Equity and Related - ------- Stockholder Matters -----------------------------------------------------\nFor information regarding the markets in which the Company's common stock is traded, see the cover page hereof, and for information regarding the high and low sales prices of the Company's common stock for the last two calendar years, see Note 9 to the Consolidated Financial Statements in the Annual Report to Shareholders, incorporated herein by reference.\nAs of March 18, 1994, the Company had approximately 40,000 holders of record of its common stock.\nIn April 1992 the Company paid a dividend of $0.026 per share of common stock. The Company paid per share dividends of $0.040 in July and October of 1992 and in January and April of 1993. In each of July and October of 1993 and January of 1994, the Company paid dividends of $0.048 per share. The dividends have been adjusted to reflect a three-for-two stock split and a five-for-four stock split which the Company declared on its common stock to holders of record on May 18, 1992 and December 17, 1993, respectively.\nItem 6.\nItem 6. Selected Financial Data - ------- -----------------------\nThe information under the caption \"Five-Year Financial Summary\" on page 27 in the Annual Report to Shareholders is incorporated herein by reference.\nItem 7.\nItem 7. Management's Discussion and Analysis of Results of Operations - ------- and Financial Condition -------------------------------------------------------------\nThe information under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on pages 28 through 31 in the Annual Report to Shareholders is incorporated herein by reference.\nItem 8.\n\nItem 8. Financial Statements and Supplementary Data - ------- -------------------------------------------\nThe consolidated financial statements of Mattel, Inc. and Subsidiaries, together with the report of Price Waterhouse dated February 8, 1994, included on pages 32 through 51 in the Annual Report to Shareholders are incorporated herein by reference.\nItem 9.\nItem 9. Changes in and Disagreements with Accountants on Accounting - ------- and Financial Disclosure -----------------------------------------------------------\nNone\nPART III --------\nItem 10.\n\n\nItem 10. Directors and Executive Officers of the Registrant - --------- --------------------------------------------------\nInformation required under this Item relating to members of the Board of Directors is incorporated by reference herein from the Company's 1994 Notice of Annual Meeting of Stockholders and Proxy Statement. The information with respect to executive officers of the Company appears under the heading \"Executive Officers of the Registrant\" in Part I herein.\nItem 11.\nItem 11. Executive Compensation - -------- ----------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1994 Notice of Annual Meeting of Stockholders and Proxy Statement.\nItem 12.\nItem 12. Security Ownership of Certain Beneficial Owners and - -------- Management ---------------------------------------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1994 Notice of Annual Meeting of Stockholders and Proxy Statement.\nItem 13.\nItem 13. Certain Relationships and Related Transactions - -------- ----------------------------------------------\nThe information required under this Item is incorporated by reference herein from the Company's 1994 Notice of Annual Meeting of Stockholders and Proxy Statement.\nPART IV -------\nItem 14.\nItem 14. Exhibits, Financial Statements, and Reports on Form 8-K - -------- -------------------------------------------------------\n(a) The following documents are filed as part of this report:\nAnnual Report Page Number(1) ------------- (1) Financial Statements\nConsolidated Balance Sheets as of 32-33 December 31, 1993 and December 31, 1992\nConsolidated Results of Operations for 34 the years ended December 31, 1993, December 31, 1992 and December 31, 1991\nConsolidated Statements of Cash Flows for 35 the years ended December 31, 1993, December 31, 1992 and December 31, 1991\nConsolidated Statements of Shareholders' 36 Equity for the years ended December 31, 1993, December 31, 1992 and December 31, 1991\nNotes to Consolidated Financial Statements 37-50\nReport of Price Waterhouse, Independent Accountants 51 to the Company\n(1) Incorporated by reference from the indicated pages of the Annual Report to Shareholders for the year ended December 31, 1993. With the exception of the information incorporated by reference in Items 1, 5, 6, 7, 8 and 14 of this report, the Annual Report to Shareholders is not deemed filed as part of this report.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors and Stockholders of Fisher-Price, Inc.\nWe have audited the consolidated balance sheet of Fisher-Price, Inc. and subsidiaries as of January 3, 1993, and the related consolidated statements of income, stockholder's equity and cash flows for the fiscal year then ended. We have also audited the financial statement schedules. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Fisher-Price, Inc. and subsidiaries as of January 3, 1993, and the consolidated results of their operations and their cash flows for the fiscal year then ended in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\n/s/ Coopers & Lybrand - --------------------- Boston, Massachusetts February 4, 1993\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo the Board of Directors and Stockholders of Fisher-Price, Inc.:\nWe have audited the consolidated statement of income, stockholders' equity and cash flows of Fisher-Price, Inc. (a Delaware Corporation) and subsidiaries for the six months ended December 29, 1991, prior to the restatement (and, therefore, are not presented herein) for the merger between Mattel, Inc. and Fisher-Price, Inc. as described in Note 2 to the Mattel, Inc. and subsidiaries consolidated financial statements included in Mattel, Inc.'s Form 10-K as of December 31, 1993. Fisher-Price, Inc.'s consolidated financial statements and schedules related thereto referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on Fisher-Price, Inc.'s consolidated financial statements and schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Fisher-Price, Inc. and subsidiaries for the six months ended December 29, 1991, in conformity with generally accepted accounting principles.\nOur audit was made for the purpose of forming an opinion on the basic financial statements prior to the restatement, taken as a whole. The schedules, prior to the restatement (and therefore, not presented herein), listed in Part IV, Item 14(a)2 are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. Fisher-Price, Inc.'s schedules, prior to restatement, have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements, prior to restatement, taken as a whole.\n/s/ ARTHUR ANDERSEN & CO. - ------------------------- Rochester, New York February 11, 1992\n(2) Financial Statement Schedules for the years ended December 31, 1993, December 31, 1992 and December 31, 1991 (1)\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties\nSchedule VIII - Valuation and Qualifying Accounts and Allowances\n(3) Exhibits (Listed by numbers corresponding to Item 601 of Regulation S-K)\n2.0 Agreement and Plan of Merger, dated as of August 19, 1993, by and among the Company, MAT Acquisition, Inc. and Fisher-Price, Inc. (incorporated by reference from Exhibit 2.1 to the Company's Registration Statement on Form S-4, Registration Statement No. 33-50749)\n3.0 Restated Certificate of Incorporation of the Company\n3.1 By-laws of the Company, as amended to date (incorporated by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n4.0 Rights Agreement, dated as of February 7, 1992, between the Company and The First National Bank of Boston, as Rights Agent (incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A, dated February 12, 1992)\n(The Company has not filed certain long-term debt instruments under which the principal amount of securities authorized to be issued does not exceed 10% of the total assets of the Company. Copies of such agreements will be provided to the Securities and Exchange Commission upon request.)\n10.0 Credit Agreement (Multi-Year Facility) dated as of March 18, 1994 among the Company, the Banks named therein and Bank of America National Trust and Savings Association, as Agent (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated March 23, 1994)\n10.1 Credit Agreement (364-Day Facility) dated as of March 18, 1994 among the Company, the Banks named therein and Bank of America National Trust and Savings Association, as Agent (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated March 23, 1994)\n(1) All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n10.2 Amended and Restated Transfer and Administration Agreement dated as of March 18, 1994 among the Company, Mattel Sales Corp., the Banks named therein and Nationsbank of Texas, N.A., as Agent (incorporated by reference to Exhibit 99.3 to the Company's Current Report on Form 8-K dated March 23, 1994)\n10.3 Underwriting Agreement dated May 19, 1993 between the Company, Morgan Stanley & Co. Incorporated and Kidder, Peabody & Co. Incorporated\n10.4 Stock Subscription Warrant dated as of June 28, 1991 between Fisher-Price and certain investors (incorporated by reference to Exhibit 4(c) to Fisher-Price's Report on Form 10-K for the transition period from July 1, 1991 to December 29, 1991)\n10.5 Third Amended and Restated Credit Agreement dated as of March 19, 1993 among the Company, the Banks named therein, Bank of America National Trust and Savings Association, as Agent and Bank of America National Trust and Savings Association, as Collateral Agent (\"Third Amended and Restated Credit Agreement\") (incorporated by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated September 29, 1993)\n10.6 First Amendment to Third Amended and Restated Credit Agreement, dated as of July 19, 1993, among the Company, the Banks named therein, Bank of America National Trust and Savings Association, as Agent, and Bank of America National Trust and Savings Association, as Collateral Agent (incorporated by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated September 29, 1993)\n10.7 Second Amendment to Third Amended and Restated Credit Agreement, dated as of November 8, 1993, among the Company, the Banks named therein, Bank of America National Trust and Savings Association, as Agent and Bank of America National Trust and Savings Association, as Collateral Agent\n10.8 Transfer and Administration Agreement, dated as of March 19, 1993, among Mattel Sales Corp., Mattel, Inc., the Banks named therein and Nationsbank of Texas, N.A., as Agent (incorporated by reference to Exhibit 99.3 to the Company's Current Report on Form 8-K dated September 29, 1993)\n10.9 Underwriting Agreement dated July 31, 1992 between the Company, Morgan Stanley & Co. Incorporated and Kidder, Peabody & Co. Incorporated (incorporated by reference to Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\nExecutive Compensation Plans and Arrangements of the Company - ------------------------------------------------------------\n10.10 Form of Indemnity Agreement between Mattel and its directors and certain of its executive officers (incorporated by reference to Exhibit B to Notice of Annual Meeting of Stockholders of the Company dated March 24, 1987)\n10.11 Form of Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10.6 of Amendment No. 1 of the Company's Annual Report on Form 10-K for the fiscal year ended December 26, 1987)\n10.12 Form of Employment Agreement between the Company and certain executive officers (incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992)\n10.13 Form of Amended & Restated Employment Agreement between the Company and certain executive officers\n10.14 Mattel, Inc. 1993 Management Incentive Plan Highlights\n10.15 Mattel, Inc. 1993 - 1995 Long-Term Incentive Plan Highlights (incorporated by reference to Exhibit 99.4 to the Company's Current Report on Form 8-K dated September 29, 1993)\n10.16 Mattel, Inc. Financial Security Program Agreement for certain officers (incorporated by reference to Exhibit 10.7 of the Company's Registration Statement No. 2-95161 on Form S-1, filed January 7, 1985)\n10.17 Form of Deferred Compensation Plan for Directors (incorporated by reference to Exhibit No. 10.11 of Amendment No. 1 of the Company's Annual Report on Form 10-K for the year ended December 26, 1987)\n10.18 Mattel, Inc. 1990 Stock Option Plan (incorporated by reference to Exhibit A to the Notice of Annual Meeting of Stockholders and Proxy Statement of the Company dated March 15, 1990)\n10.19 Amendment No. 1 to the Mattel, Inc. 1990 Stock Option Plan (incorporated by reference to the information under the heading \"Amendment to Mattel 1990 Stock Option Plan\" on page of the Joint Proxy Statement/Prospectus of the Company and Fisher-Price included in the Company's Registration Statement on Form S-4, Registration Statement No. 33-50749)\n10.20 Form of Award Agreement evidencing award of stock appreciation rights granted pursuant to the Company's 1990 Stock Option Plan to certain executive officers of the Company (\"Award Agreement\") (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991)\n10.21 Form of First Amendment to Award Agreement\n10.22 Form of Restricted Stock Award Agreement under the Mattel 1990 Stock Option Plan\n10.23 Mattel, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.10 of the Company's Annual Report on Form 10-K for the fiscal year ended December 29, 1990)\n10.24 Description of the Mattel, Inc. Deferred Compensation Plan for Officers (incorporated by reference to Exhibit 10.16 to the Mattel, Inc. Annual Report on Form 10-K for the year ended December 31, 1991)\nExecutive Compensation Plans and Arrangements of Fisher-Price - -------------------------------------------------------------\n10.25 Form of Employment Agreement, dated August 16, 1993, between Fisher-Price and certain executive officers\n10.26 Form of Employment Agreement, dated August 16, 1993, between Fisher-Price and an executive officer\n10.27 Form of Employment Agreement, dated as of March 12, 1993, between Fisher-Price and Ronald J. Jackson (incorporated by reference to Exhibit 10(f)(1) to Fisher-Price's Annual Report on Form 10-K for the fiscal year ended January 3, 1993)\n10.28 Form of Amendment, dated August 16, 1993, to Employment Agreement, dated as of March 12, 1993, between Fisher-Price and Ronald J. Jackson\n10.29 Form of Employment Agreement, dated as of February 25, 1992, between Fisher-Price and certain executive officers (incorporated by reference to Exhibit 10(f)(2) to Fisher-Price's Form 10-K for the transition period from July 1, 1991 to December 29, 1991)\n10.30 Deferred Compensation Plan for Outside Directors of Fisher-Price (incorporated by reference to Exhibit 10(g) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.31 Fisher-Price Long-Term Incentive Plan of 1991 (incorporated by reference to Exhibit 10(h) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.32 Fisher-Price Executive Incentive Bonus Plan (incorporated by reference to Exhibit 10(i) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.33 First Amendment to Executive Incentive Bonus Plan, dated as of February 12, 1992 (incorporated by reference to Exhibit 10(i)(1) to Fisher-Price's Report on Form 10-K for the transition period from July 1, 1991 to December 29, 1991)\n10.34 The Fisher-Price Management Incentive Bonus Plan (incorporated by reference to Exhibit 10(j) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.35 Fisher-Price Matching Savings Plan (incorporated by reference to Exhibit 10(k) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.36 The Fisher-Price Pension Plan (1989 Restatement) (incorporated by reference to Exhibit 10(l) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.37 The Fisher-Price Profit Sharing and Retirement Savings Plan (1989 Restatement) (incorporated by reference to Exhibit 10(m) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.38 The Fisher-Price Deferral and Compensation Adjustment Benefit Plan (incorporated by reference to Exhibit 10(o) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n10.39 The Fisher-Price Salaried Employees Compensation and Benefits Protection Plan (incorporated by reference to Exhibit 10(p) to Fisher-Price's Registration Statement on Form 10 dated June 28, 1991)\n11.0 Computation of Income per Common and Common Equivalent Share\n13.0 Pages 27 through 53 of the Mattel, Inc. Annual Report to Shareholders for the year ended December 31, 1993\n21.0 Subsidiaries of the Registrant\n23.0 Consent of Price Waterhouse\n23.1 Consent of Arthur Andersen & Co.\n23.2 Consent of Coopers & Lybrand\n24.0 Power of Attorney (on page 28 of Form 10-K)\n(b) Reports on Form 8-K\nMattel, Inc. filed the following Current Reports on Form 8-K during the quarterly period ended December 31, 1993\nFinancial Date of Report Items Reported Statements Filed ------------------ -------------- ---------------- September 29, 1993 7 None October 18, 1993 5, 7 None November 3, 1993 5, 7 None November 30, 1993 5, 7 None\n(c) Exhibits Required by Item 601 of Regulation S-K\nSee Item (3) above\n(d) Financial Statement Schedules\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other than Related Parties\nSchedule VIII - Valuation and Qualifying Accounts and Allowances\nCopies of Form 10-K (which includes Exhibit 24.0), Exhibits 11.0, 13.0, 21.0, 23.0, 23.1, 23.2, and the Annual Report to Shareholders are available to stockholders of the Company without charge. Copies of other Exhibits can be obtained by stockholders of the Company upon payment of ten cents per page for such Exhibits. Written requests should be sent to Secretary, Mattel, Inc., 333 Continental Boulevard, El Segundo, California 90245-5012.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nMATTEL, INC. Registrant\nBy: /s/ Gary P. Rolfes ----------------------- Gary P. Rolfes Senior Vice President & Date: As of March 24, 1994 Controller --------------------\nPOWER OF ATTORNEY -----------------\nWe, the undersigned directors and officers of Mattel, Inc. do hereby severally constitute and appoint John W. Amerman, N. Ned Mansour, Michael G. McCafferty, Robert Normile and John L. Vogelstein, and each of them, our true and lawful attorneys and agents, to do any and all acts and things in our name and behalf in our capacities as directors and officers and to execute any and all instruments for us and in our names in the capacities indicated below, which said attorneys and agents, or any of them, may deem necessary or advisable to enable said Corporation to comply with the Securites Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with this Annual Report on Form 10-K, including specifically, but without limitation, power and authority to sign for us or any of us, in our names in the capacities indicated below, any and all amendments hereto; and we do each hereby ratify and confirm all that said attorneys and agents, or any one of them, shall do or cause to be done by virtue hereof.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES ---------------------------------\nTo the Board of Directors of Mattel, Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 8, 1994, appearing on page 51 of the December 31, 1993 Annual Report to Shareholders of Mattel, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) and the reports of other auditors also included an audit of the Financial Statement Schedules listed in Item 14(a)(2) of this Form 10-K. In our opinion, based on our audits and the reports of other auditors, these Financial Statement Schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n/s/ PRICE WATERHOUSE - ----------------------- Los Angeles, California February 8, 1994\nSCHEDULE VIII\nMATTEL, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS AND ALLOWANCES\n(In thousands)"},"word_count":{"kind":"number","value":9010,"string":"9,010"},"character_count":{"kind":"number","value":60125,"string":"60,125"}}},{"rowIdx":299,"cells":{"filename":{"kind":"string","value":"19150_1993.txt"},"id":{"kind":"string","value":"19150_1993"},"year":{"kind":"string","value":"1993"},"cik":{"kind":"string","value":"19150"},"text":{"kind":"string","value":"ITEM 1. BUSINESS\nGENERAL\nChampion International Corporation was incorporated under the laws of the State of New York on April 28, 1937. References to the \"Company\" include Champion International Corporation and its subsidiaries at December 31, 1993, unless the context otherwise requires.\nThe Company is one of the leading domestic manufacturers of paper for business communications, commercial printing, publications and newspapers. In addition, the Company has significant plywood and lumber manufacturing operations and owns or controls approximately 5,072,000 acres of timberlands in the United States. The Company's Canadian and Brazilian subsidiaries also own or control significant timber resources supporting their operations.\nThe Company's business segments are paper and wood products. See Note 13 of Notes to Financial Statements on pages 37 and 38 of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1993 (the \"Company's 1993 Annual Report\"), which Note is incorporated by reference herein, for information concerning the Company's business segments and operations in different geographic areas for 1991, 1992 and 1993.\nPAPER\nSee the Net Sales table on page 18 of the Company's 1993 Annual Report, which table is incorporated by reference herein, for information concerning the net sales to unaffiliated customers of the various products of the paper business for 1991, 1992 and 1993.\nPRINTING AND WRITING PAPERS\nThe printing and writing papers business manufactures and sells printing and writing papers, bleached paperboard and pulp. The principal domestic manufacturing properties of this operation consist of integrated pulp and paper mills at Courtland, Alabama; Canton, North Carolina; and Pensacola, Florida; and a paper mill at Hamilton, Ohio. As of December 31, 1993, these mills had an annual capacity of approximately 1,846,000 tons of pulp and 2,066,000 tons of printing and writing papers and bleached paperboard.\nMost of the pulp produced by the printing and writing papers business is used in its own paper mills; approximately 14%, produced at the Pensacola and Courtland mills, was sold in the open market in 1993. A portion of the fiber requirements of this business also is supplied by other Company pulp mills, and approximately 4% of its fiber requirements in 1993 were purchased from third- party suppliers.\nUncoated papers produced by the printing and writing papers business are used for computer forms, copier paper and envelope papers. Coated papers are used in catalogs, magazines, brochures, labels and annual reports.\nIn 1993, 63% of this operation's bleached paperboard production was used by the Company's DairyPak unit, which converts polyethylene-coated paperboard into milk and juice cartons and ovenable packaging. The balance either was sold to independent purchasers, primarily for conversion to cups, or was exported.\nThe Company leases substantial portions of the Courtland mill under 10 long- term net leases which expire between 1997 and 2029. Each of these leases provides for rental payments over its term sufficient to pay interest on and to retire the industrial development or pollution control revenue bonds issued in connection with the financing of the property subject to such lease. The Company is required to purchase, or has the option to purchase, the property subject to each such lease for a nominal sum at the time the related bonds are retired.\nThe domestic printing and writing papers business and the publication papers business jointly maintain 11 sales offices in various parts of the United States, as well as an order services office in Hamilton, Ohio, for the sale of their products to direct purchasers and through paper merchants. Certain of these sales offices are shared with the newsprint and kraft operations.\nChampion Papel e Celulose Ltda., a 99%-owned subsidiary (\"Champion Papel\"), is a major integrated manufacturer of pulp and printing and writing papers in Brazil with net sales to unaffiliated customers of (U.S.) $272,498,000 in 1993. As of December 31, 1993, this mill had an annual capacity of approximately 334,000 tons of pulp and 373,000 tons of paper. In addition to being a leading supplier of printing and writing papers in Brazil, Champion Papel exports a substantial portion of its paper production.\nPUBLICATION PAPERS\nThe publication papers business manufactures and sells coated and uncoated publication papers and pulp. The manufacturing properties of this operation consist of integrated pulp and paper mills at Bucksport, Maine; Deferiet, New York; Quinnesec, Michigan; and Sartell, Minnesota. As of December 31, 1993, these mills had an annual capacity of approximately 810,000 tons of pulp and 1,250,000 tons of publication papers.\nA significant portion of the fiber requirements of the publication papers business is supplied by its own mills. In addition, a portion of its fiber requirements is supplied by other Company pulp mills, and approximately 26% of its fiber requirements in 1993 were purchased from third-party suppliers.\nThe Company manufactures pulp for sale in the open market at the Quinnesec mill. In 1993, approximately 60% of the pulp production of this mill, or 215,000 tons, was sold in the open market through the Company's headquarters in Stamford, Connecticut, as well as a sales office in Appleton, Wisconsin. The balance was used in the production of paper at the Quinnesec mill and at the Company's printing and writing papers mills.\nThe Company's publication papers are used primarily for consumer magazines, direct mail catalogs, directories, textbooks and coupons. Sales are made to direct purchasers and through paper merchants and brokers from the 11 sales offices jointly maintained by the publication papers operation and the printing and writing papers operation, and from the Hamilton, Ohio order services office.\nThe Company leases the building which houses one of the paper machines at the Sartell mill until 2008. Thereafter, the Company has options to renew the lease for five terms of five years each. The Company also has the option to purchase the building at its then-current market value at the end of the initial term in 2008 or at the end of each five-year renewal term.\nThe Company leases certain water pollution control facilities at the Deferiet mill until November 30, 1994. The lease provides for rental payments over its term sufficient to pay interest on and to retire the tax-exempt bonds (in the original principal amount of $7 million) issued to finance the acquisition of those facilities. The Company has the option to purchase the facilities for a nominal sum at the time the bonds are retired.\nNEWSPRINT\nThe newsprint business manufactures pulp and manufactures and sells newsprint, directory paper and groundwood specialties. The manufacturing properties of this operation consist of integrated pulp and paper mills at Lufkin and Sheldon, Texas. As of December 31, 1993, these mills had an annual capacity of approximately 1,191,000 tons of pulp (which includes 150,000 tons of recycled pulp) and 952,000 tons of newsprint, directory paper and groundwood specialties.\nVirtually all of the newsprint operation's pulp production is used in its own paper mills; approximately 2% was sold in the open market in 1993.\nMost of the newsprint produced by the Company is sold in the Southwest, Southeast and Midwest. In general, sales are made directly to publishers and printers through four sales offices, three of which are shared with the printing and writing papers and publication papers operations, and one order services office.\nPULP\nFor information concerning market pulp produced at the Pensacola and Courtland mills, see the section captioned Printing and Writing Papers above, and for information concerning market pulp produced at the Quinnesec mill, see the section captioned Publication Papers above.\nWeldwood of Canada Limited, a Canadian subsidiary in which the Company has approximately 85% ownership (\"Weldwood\"), manufactures bleached softwood kraft pulp at its mill in Hinton, Alberta, Canada. As of December 31, 1993, this mill had an annual capacity of approximately 424,000 tons. In 1993, approximately 29% of the mill's pulp production was used in the Company's own publication papers and printing and writing papers mills. The balance was sold in the open market through the Company's headquarters in Stamford, Connecticut, a Company sales office in Appleton, Wisconsin and a Weldwood sales office in Bad Homburg, Germany.\nCariboo Pulp & Paper Company, a joint venture owned equally by Weldwood and Daishowa-Marubeni International Limited, operates a bleached softwood kraft pulp mill in Quesnel, British Columbia, Canada. As of December 31, 1993, this mill had an annual capacity of approximately 340,000 tons. In 1993, approximately 13% of Weldwood's 50% share of the mill's pulp production was used in the Company's own publication papers and printing and writing papers mills. The balance of Weldwood's share was sold in the open market through the Company's headquarters in Stamford, Connecticut, a Company sales office in Appleton, Wisconsin and a Weldwood sales office in Bad Homburg, Germany.\nWhile certain of the Company's mills purchase pulp in the open market, the Company and Weldwood overall are net sellers of pulp. In 1993, the Company and Weldwood in the aggregate produced approximately 855,000 tons of pulp for sale to unaffiliated purchasers, while the Company used approximately 314,000 tons of pulp purchased from third-party suppliers, resulting in net market pulp of approximately 541,000 tons.\nKRAFT\nThe Company produces pulp, unbleached linerboard and kraft paper for multiwall and grocery bags at its mill in Roanoke Rapids, North Carolina. As of December 31, 1993, this mill had an annual capacity to produce approximately 489,000 tons of pulp, 402,000 tons of linerboard and 105,000 tons of kraft paper. All of this mill's pulp production is used at the mill. In addition, approximately 7% of its fiber requirements in 1993 were purchased from third- party suppliers. The linerboard and kraft paper produced at the Roanoke Rapids mill are sold to converters through three sales offices, two of which are shared with the printing and writing papers and publication papers operations, and one order services office.\nPAPER DISTRIBUTION OPERATION\nNationwide Papers is the Company's wholly owned distributor of paper and paper products. Its marketing operations are carried out through 28 wholesale warehouse facilities in 18 states. In addition, Nationwide Papers operates a facility which converts rolls of bleached paperboard into sheets for sale to textile, furniture and tobacco producers. In 1993, approximately 75% of its sales were attributable to merchandise purchased from numerous manufacturers other than the Company. However, Nationwide Papers is not dependent on any single supplier for such merchandise.\nWOOD PRODUCTS\nThe Company is a major producer of plywood and lumber. The Company's wood products business is conducted through its domestic wood products operations and through the wood products operations of Weldwood.\nThe principal wood products manufacturing facilities operated by the Company and by Weldwood are summarized under Item 2\n\n\nITEM 2. PROPERTIES\nIn 1993, the overall operating rate for the Company's domestic and foreign manufacturing facilities exceeded 98% of capacity in the paper segment, 80% of capacity for lumber and studs, and 97% of capacity for panelboard (plywood and waferboard). Production curtailments in the Company's paper segment were attributable primarily to scheduled maintenance. Production curtailments in the wood products segment were attributable primarily to log supply shortages resulting from the scarcity of timber, as well as the process of disposing of several mills.\nReference is made to Item 1 of this Report for information concerning the general character, adequacy and capacity of the principal plants, timber properties and other materially important physical properties of the Company. The following lists show the location, nature and ownership of the Company's principal plants. Except as indicated, none of these plants is subject to a mortgage and all are owned in fee.\nPAPER\nPRINTING AND WRITING PAPERS\n(a) Integrated pulp and printing and writing papers mills:\n(i) Courtland, Alabama/1/; (ii) Canton, North Carolina; (iii) Pensacola, Florida; and (iv) Mogi Guacu, Brazil.\n(b) The Company operates a printing and writing papers mill in Hamilton, Ohio.\n(c) The Company operates a plant in Waynesville, North Carolina which applies polyethylene coating to bleached paperboard and which also converts roll stock into cut-size paper.\n(d) The Company operates five plants which convert polyethylene-coated paperboard into milk and juice cartons and one plant which converts polyethylene-coated paperboard into ovenable packaging. All of these plants are located in the United States.\nPUBLICATION PAPERS\n(e) Integrated pulp and publication papers mills:\n(i) Bucksport, Maine; (ii) Deferiet, New York/2/; (iii) Quinnesec, Michigan; and (iv) Sartell, Minnesota/2/.\n- ----------\n/1/For Courtland, Alabama mill lease information, see Item 1 - Paper of this Report.\n/2/For Deferiet, New York and Sartell, Minnesota mill lease information, see Item 1 - Paper of this Report.\nNEWSPRINT\n(f) Integrated pulp and newsprint mills:\n(i) Lufkin, Texas; and (ii) Sheldon, Texas.\nPULP\n(g) The Company's printing and writing papers mills in Pensacola, Florida and Courtland, Alabama and publication papers mill in Quinnesec, Michigan also produce market pulp.\n(h) Weldwood operates a pulp mill in Hinton, Alberta, Canada and owns 50% of a joint venture which operates a pulp mill in Quesnel, British Columbia, Canada.\nKRAFT\n(i) The Company operates an integrated pulp, unbleached linerboard and kraft paper mill in Roanoke Rapids, North Carolina.\nWOOD PRODUCTS\n(a) The Company operates three softwood plywood plants in the United States.\n(b) Weldwood operates two softwood plywood plants and one specialty hardwood plywood plant in Canada. One of these plants is located on leased land.\n(c) The Company operates seven softwood lumber mills in the United States.\n(d) Weldwood operates five softwood lumber mills in Canada. One of these mills is located on leased land.\n(e) Each of Babine Forest Products Company and Houston Forest Products Company, joint ventures in which Weldwood has an interest, operates a mill for the production of softwood lumber in Canada. Both mills are located on leased land.\n(f) Weldwood operates one waferboard plant in Canada.\nITEM 3.\nITEM 3. LEGAL PROCEEDINGS\nOn January 4, 1991, a class action was brought against the Company in state court in Tennessee. The class consisted of all Tennessee residents who own or lease land around Douglas Lake or along the Pigeon River. Subsequently, the case was transferred to the United States District Court for the Eastern District of Tennessee. While the original complaint sought $5 billion in compensatory and punitive damages, immediately prior to trial the plaintiffs reduced their demand to $367.9 million. The plaintiffs originally claimed damages for both personal injury and property damage, but the personal injury claims were dismissed. The case proceeded to trial on plaintiffs' theory that discharges of hazardous materials, including dioxin, from the Company's Canton, North Carolina mill had decreased property values along the river and the lake. On October 16, 1992, a mistrial was declared when the jury was unable to reach a unanimous verdict. On May 3, 1993, the court approved a settlement of the action providing for a payment of $6.5 million by the Company. On June 1, 1993, the court's approval of the settlement was appealed.\nOn September 18, 1992, an action was brought in the District Court of Brazoria County, Texas by 26 individuals engaged in seafood-related businesses against the Company, Simpson Pasadena Paper Company, the Gulf Coast Waste Disposal Authority and eight other corporations and individuals. The action sought unspecified damages for lost business profits, diminution in property value and mental anguish allegedly resulting from the purported discharge of dioxin into the Brazos River, Galveston Bay, the Neches River and their adjacent waters, from the Company's Sheldon and Lufkin, Texas mills, Simpson's Pasadena, Texas mill and the other defendants' mills and plants. The Company sold the Pasadena mill to Simpson in 1987 but may be liable for damages, if any, arising from wastewater discharges which occurred prior to the sale. On September 2, 1993, at the plaintiffs' request, the action was dismissed with respect to the Company's Lufkin mill. In December 1993, the action was settled for an immaterial amount.\nOn September 18, 1992, an action was brought in the District Court of Harris County, Texas by 71 individuals primarily engaged in seafood-related businesses against the Company, Simpson Pasadena Paper Company, the Gulf Coast Waste Disposal Authority and eight other corporations and individuals. The action sought unspecified damages for lost business profits, diminution in property value and mental anguish allegedly resulting from the purported discharge of dioxin into the Brazos River, Galveston Bay, the Neches River and their adjacent waters, from the Company's Sheldon and Lufkin, Texas mills, Simpson's Pasadena, Texas mill and the other corporate defendants' mills and plants. The Company sold the Pasadena mill to Simpson in 1987 but may be liable for damages, if any, arising from wastewater discharges which occurred prior to the sale. On September 2, 1993, at the plaintiffs' request, the action was dismissed with respect to the Company's Lufkin mill. In December 1993, the action was settled for an immaterial amount.\nOn November 9, 1992, an action was brought against the Company in the Circuit Court for Baldwin County, Alabama purportedly on behalf of a class consisting of all persons who own land along Perdido Bay in Florida and Alabama. The action originally sought $500 million in compensatory and punitive damages for personal injury, intentional infliction of emotional distress and diminution in property value allegedly resulting from the purported discharge of hazardous substances, including dioxin, from the Company's Pensacola, Florida mill into Eleven Mile Creek, which flows into Perdido Bay. However, in February 1994, the plaintiffs reduced their demand to not more than $50,000 for each class member. It is anticipated that the class, if certified, will consist of approximately 1,000 members. The parties currently are engaged in discovery.\nThe Company and many other corporations, municipalities and individuals are defendants in three separate actions filed in the District Court of Galveston County, Texas by numerous individuals on March 8, 1993, April 20, 1993 and May 13, 1993, respectively. Each of these actions seeks compensatory and punitive damages in excess of $5 billion for personal injury and property damage allegedly resulting from the purported disposal of waste materials, including hazardous substances, into the McGinnis Waste Disposal Site located at Hall's Bayou Ranch.\nOn July 17, 1991, an action was brought in the United States District Court for the District of Colorado against Weldwood and 14 other Canadian forest products companies purportedly on behalf of a class of United States purchasers of Canadian lumber. The action, seeking injunctive relief and unspecified treble damages, alleged a conspiracy by the defendants and others to fix freight charges for, and to sell on a delivered price basis, Western Canadian softwood lumber, thereby allegedly artificially raising, fixing, maintaining or stabilizing prices in violation of United States antitrust laws. On January 8, 1993, the action was dismissed, upon the motion of the defendants, for reasons of comity. On January 20, 1993, the plaintiff filed a notice of appeal. In February 1994, the action was settled for an immaterial amount.\nThe Company is vigorously defending each of the pending actions described above.\nThe Company also is involved in other legal and administrative proceedings and claims of various types. While any litigation contains an element of uncertainty, management, based upon the opinion of the Company's General Counsel, presently believes that the outcome of each such proceeding or claim which is pending or known to be threatened (including the actions described above), or all of them combined, will not have a material adverse effect on the Company.\nITEM 4.\nITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT/1/\nJohn A. Ball (age 65) is a Senior Vice President of the Company, a position which he has held since March 1983. He has responsibility for corporate and marketing communications, governmental affairs, public affairs and facilities services.\nL. Scott Barnard (age 51) is an Executive Vice President of the Company, a position which he has held since August 1992. He has responsibility for sales and marketing for the printing and writing papers and publication papers businesses. From February 1989 to August 1992, he was Vice President-Sales and Marketing for the printing and writing papers and publication papers businesses.\nGerald J. Beiser (age 63) is Senior Vice President-Finance of the Company, a position which he has held since 1975.\nWilliam H. Burchfield (age 58) is an Executive Vice President of the Company, a position which he has held since November 1982. He has responsibility for the domestic printing and writing papers business.\nMark V. Childers (age 41) is Senior Vice President-Organizational Development and Human Resources of the Company, a position which he has held since August 1992. From June 1991 to August 1992, he was Vice President-Organizational Development Project of the Company. From August 1988 to June 1991, he was Manager-Organizational Development at the Lufkin, Texas mill.\nRichard J. Diforio, Jr. (age 58) is a Senior Vice President of the Company, a position which he has held since November 1992. He has responsibility for environmental, health and safety affairs. From September 1990 to November 1992, he was Vice President-Environment, Health and Safety of the Company. From September 1986 to September 1990, he was Vice President-Environmental Affairs of the Company.\nJoe K. Donald (age 51) is an Executive Vice President of the Company, a position which he has held since August 1989. He heads the publication papers business. From December 1987 to August 1989, he was Vice President- Manufacturing of the printing and writing papers business.\nMark A. Fuller, Jr. (age 61) is an Executive Vice President of the Company, a position which he has held since August 1980. He has responsibility for the Company's overall marketing program as well as for Nationwide Papers, Champion Export, pulp sales and sales of wood chemicals and by-products. From July 1986 to August 1989, he headed the publication papers business.\nMarvin H. Ginsky (age 63) is Senior Vice President and General Counsel of the Company. He was elected a Senior Vice President in May 1981. He has been the General Counsel since 1973.\nL.C. Heist (age 62) is President and Chief Operating Officer and a director of the Company, positions which he has held since December 1987.\nBurton G. MacArthur, Jr. (age 47) is an Executive Vice President of the Company, a position which he has held since January 1990. He has responsibility for the newsprint and kraft operations. From March 1989 to January 1990, he was Vice President-Management Information Services of the Company.\n_______________________________\n/1/The term of office for each executive officer expires at the Annual Meeting of the Board of Directors of the Company scheduled to be held on May 19, 1994.\nKenwood C. Nichols (age 54) is Vice Chairman and a director of the Company, positions which he has held since August 1989. He has been the principal accounting officer of the Company since July 1983. He also has responsibility for internal audit, corporate analysis, tax affairs, management information services, mineral resources, corporate security and the Company's real estate subsidiaries. From July 1983 to August 1989, he was a Senior Vice President of the Company.\nRichard E. Olson (age 56) is an Executive Vice President of the Company, a position which he has held since December 1987. He has responsibility for engineering, technology, manufacturing support and major projects. From December 1987 to January 1990, he had responsibility for the newsprint, domestic pulp and kraft operations.\nRichard L. Porterfield (age 47) is an Executive Vice President of the Company, a position which he has held since August 1992. He heads the forest products unit, which consists of domestic timberlands operations and the domestic wood products business. From January 1990 to August 1992, he was Senior Vice President- Organizational Development and Human Resources of the Company. From August 1989 to January 1990, he was Vice President-Organizational Development Project of the Company. From June 1988 to August 1989, he was Director-Participative Management and Administration of the forest products unit.\nAndrew C. Sigler (age 62) is Chairman of the Board of Directors and Chief Executive Officer of the Company. He was elected Chairman of the Board effective January 1, 1979. He has served as Chief Executive Officer since 1974 and has been a director since 1973.\nPART II\nITEM 5.\nITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company had 23,394 record holders of its Common Stock as of February 28, 1994.\nThe Company's Common Stock is traded on the New York Stock Exchange.\nRestrictions on the ability of the Company to pay cash dividends are included in several of the Company's debt instruments and the Company's Restated Certificate of Incorporation. At December 31, 1993, the most restrictive of these limitations required the Company to maintain tangible net worth (as defined below) of at least $2.770 billion. As a result of this requirement, such amount is unavailable for the payment of dividends. Approximately $454 million of tangible net worth at December 31, 1993 was free of such restrictions. Tangible net worth is defined as shareholders' equity plus the Company's $92.50 Cumulative Convertible Preference Stock minus goodwill, unamortized debt discount and other like intangibles, all determined on a consolidated basis for the Company.\nFor information concerning the high and low sales prices of the Company's Common Stock for each quarterly period during the last two years and the amount of dividends paid on the Company's Common Stock in each quarterly period during the last two years, see the section on the inside back cover of the Company's 1993 Annual Report captioned Common Stock Prices and Dividends Paid. Said section is incorporated by reference herein.\nITEM 6.\nITEM 6. SELECTED FINANCIAL DATA\nThere is incorporated by reference herein the table on pages 50 and 51 of the Company's 1993 Annual Report captioned Eleven-Year Selected Financial Data.\nITEM 7.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThere is incorporated by reference herein the section on pages 43 to 49 of the Company's 1993 Annual Report captioned Management's Discussion and Analysis of Financial Condition and Results of Operations.\nITEM 8.\n\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThere is incorporated by reference herein the sections of the Company's 1993 Annual Report captioned Consolidated Income, Consolidated Retained Earnings, Consolidated Balance Sheet, Consolidated Cash Flows, Notes to Financial Statements and Report of Independent Public Accountants, which sections are located on pages 22, 23, 24, 25, 26 to 40, and 41, respectively, of the Company's 1993 Annual Report.\nITEM 9.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEM 10.\n\n\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nSee the section captioned Executive Officers of the Registrant under Part I of this Report for information concerning the Company's executive officers.\nFor information concerning the directors of the Company, see the sections captioned The Board of Directors -The Nominees, Information on the Nominees and Directors, and Committees in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 19, 1994. Said sections are incorporated by reference herein.\nITEM 11.\nITEM 11. EXECUTIVE COMPENSATION\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 19, 1994 the sections therein captioned The Board of Directors - Directors' Compensation; and Executive Compensation - Summary Compensation Table, Option/SAR Grant Table, Option/SAR Exercise and Year-End Values Table, Pension Plan Table, and Employment and Severance Agreements.\nITEM 12.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 19, 1994 the sections therein captioned Principal Shareholders and Stock Ownership by Nominees, Directors and Named Executive Officers.\nITEM 13.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere is incorporated by reference herein from the Company's definitive Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on May 19, 1994 the section therein captioned Transactions.\nPART IV\nITEM 14.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) FINANCIAL STATEMENTS. The following Consolidated Financial Statements of Champion International Corporation and Subsidiaries, Notes to Financial Statements, and Report of Independent Public Accountants are incorporated by reference herein from the Company's 1993 Annual Report:\n(b) FINANCIAL STATEMENT SCHEDULES. The following Financial Statement Schedules and Report of Independent Public Accountants on Schedules are filed with this Annual Report on Form 10-K on the pages indicated:\nAll other schedules have been omitted since the information is not applicable, is not required or is included in the Consolidated Financial Statements or Notes to Financial Statements listed under section (a) of this Item 14.\n(c) EXHIBITS. Each Exhibit is listed according to the number assigned to it in the Exhibit Table of Item 601 of Regulation S-K. The Exhibit numbers preceded by an asterisk (*) indicate Exhibits physically filed with this Annual Report on Form 10-K. All other Exhibit numbers indicate Exhibits filed by incorporation by reference herein. Exhibit numbers 10.1 through 10.29, which are preceded by a plus sign (+), are management contracts or compensatory plans or arrangements.\nEXHIBIT NUMBER DESCRIPTION - ------ ------------\n3.1 Restated Certificate of Incorporation of the Company, filed in the State of New York on October 20, 1986 (filed by incorporation by reference to Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended December 31, 1986, Commission File No. 1-3053).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on July 18, 1988 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n3.3 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 6, 1989 (filed by incorporation by reference to\nEXHIBIT NUMBER DESCRIPTION - ------ ------------\nExhibit 4.1 to the Company's Form 8-K dated December 14, 1989, Commission File No. 1-3053).\n3.4 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 21, 1989 (filed by incorporation by reference to Exhibit 3.4 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n3.5 By-Laws of the Company (filed by incorporation by reference to Exhibit 3(ii).1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n4.1 Letter agreement dated March 29, 1991 of the Company to furnish to the Commission upon request copies of certain instruments with respect to long-term debt (filed by incorporation by reference to Exhibit 4 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n4.2 Agreement dated February 2, 1994 between the Company and Loews Corporation (filed by incorporation by reference to Exhibit 4.7 to the Company's Registration Statement on Form S-3, Commission Registration No. 33-52123).\n+10.1 Champion International Corporation 1986 Management Incentive Program, consisting of the 1986 Stock Option Plan and the 1986 Contingent Compensation Plan (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1986, Commission File No. 1-3053).\n+10.2 Amendment to Champion International Corporation 1986 Management Incentive Program (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n+10.3 Champion International Corporation Restricted Share Performance Plan, as amended (filed by incorporation by reference to Exhibit 10.2 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n+10.4 Champion International Corporation Management Incentive Program, as amended, consisting of the Amended 1976 Incentive Stock Option Plan and the Contingent Compensation Plan (filed by incorporation by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8, Commission Registration No. 2-77129).\n+10.5 Resolutions of the Board of Directors of the Company adopted on August 16, 1984 amending the Amended 1976 Incentive Stock Option Plan (filed by incorporation by reference to Exhibit 10(b) to the Company's Registration Statement on Form S-14, Commission Registration No. 2-94030).\n+10.6 Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n+10.7 Supplemental Retirement and Death Payments Agreement dated as of August 1, 1964, as amended by letter agreement dated January 9, 1965, between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.8 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\nEXHIBIT NUMBER DESCRIPTION - ------ ------------\n+10.8 Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987, providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.9 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 19.2 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.10 Amendment dated as of April 21, 1988 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.11 Amendment dated as of August 18, 1988 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.10 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.12 Amendment dated as of August 18, 1988 to Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.11 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.13 Amendment dated as of September 19, 1991 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.12 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.14 Agreement dated as of August 18, 1988 between the Company and Mr. Heist providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.15 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Heist providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.16 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Heist (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.17 Agreement dated as of October 18, 1990 between the Company and Mr. Nichols providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.18 Agreement Relating to Legal Expenses dated October 18, 1990 between the Company and Mr. Nichols providing reimbursement of certain legal expenses following a change in\nEXHIBIT NUMBER DESCRIPTION - ------ ------------\ncontrol of the Company (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.19 Amendment dated as of September 19, 1991 to Agreement dated as of October 18, 1990 between the Company and Mr. Nichols (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.20 Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.21 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Burchfield providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.22 Amendment dated as of April 21, 1988 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 19.5 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.23 Amendment dated as of September 19, 1991 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 10.22 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.24 Agreement dated as of August 18, 1988 between the Company and Mr. Olson providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.23 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.25 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Olson providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.24 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.26 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Olson (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.27 Trust Agreement dated as of February 19, 1987 between the Company and Connecticut National Bank securing certain payments under the contracts listed as Exhibit Numbers 10.8 through 10.26, among others, following a change in control of the Company (filed by incorporation by reference to Exhibit 19.11 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1- 3053).\nEXHIBIT NUMBER DESCRIPTION - ------ ------------\n+10.28 Amendment dated as of August 18, 1988 to Trust Agreement dated as of February 19, 1987 between the Company and Connecticut National Bank (filed by incorporation by reference to Exhibit 10.29 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.29 Champion International Corporation Executive Life Insurance Plan (filed by incorporation by reference to Exhibit 10.27 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n10.30 Extract from the minutes of the meeting of the Board of Directors of the Company held on October 18, 1979 relating to the $50,000 of group term life insurance provided by the Company for non- employee directors (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n10.31 Resolutions of the Board of Directors of the Company adopted on September 19, 1991 relating to the compensation of directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1991, Commission File No. 1-3053).\n10.32 Retirement Plan for Outside Directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1992, Commission File No. 1-3053).\n*11 Schedule showing calculation of primary earnings per common share and fully diluted earnings per common share.\n*13 Portions of the Annual Report to Shareholders of Champion International Corporation for the fiscal year ended December 31, 1993, which are incorporated herein by reference.\n*21 List of significant subsidiaries of the Company.\n*23.1 Opinion and Consent of the Senior Vice President and General Counsel of the Company.\n*23.2 Consent of Arthur Andersen & Co.\n*24 Power of Attorney relating to the execution and filing of this Annual Report on Form 10-K and all amendments hereto.\n(d) REPORTS ON FORM 8-K. No Reports on Form 8-K were filed during the last quarter of the period covered by this Report.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, ON THE 30TH DAY OF MARCH, 1994.\nCHAMPION INTERNATIONAL CORPORATION (Registrant)\nBy Lawrence A. Fox ----------------------------------- (LAWRENCE A. FOX) VICE PRESIDENT AND SECRETARY\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nA POWER OF ATTORNEY AUTHORIZING LAWRENCE A. FOX, MARVIN H. GINSKY AND ANDREW C. SIGLER AND EACH OF THEM TO SIGN THIS REPORT AND ALL AMENDMENTS HERETO AS ATTORNEYS-IN-FACT FOR OFFICERS AND DIRECTORS OF THE REGISTRANT IS FILED AS EXHIBIT 24 HERETO.\nSCHEDULE V\nCHAMPION INTERNATIONAL CORPORATION AND SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT\nFor the Years Ended December 31, 1993, 1992 and 1991 (in thousands of dollars)\n- ----------------- Notes: (1) Property, plant and equipment is carried at cost. (2) Effect of foreign currency translation. (3) Reclassifications and transfers to and from other accounts. (4) Cost of timber harvested charged to costs and expenses. (5) As the result of adopting, as of January 1, 1992, Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" assets formerly acquired in purchase business combinations were revalued to reflect gross values. Prior to adoption of this standard, these assets were valued net of related tax effects.\nS-1\nSCHEDULE VI\nCHAMPION INTERNATIONAL CORPORATION AND SUBSIDIARIES\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFor the Years Ended December 31, 1993, 1992 and 1991 (in thousands of dollars)\nNotes: (1) Reclassifications and transfers to and from other accounts. (2) Effect of foreign currency translation. (3) As the result of adopting, as of January 1, 1992, Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" assets formerly acquired in purchase business combinations were revalued to reflect gross values. Prior to adoption of this standard, these assets were valued net of related tax effects.\nS-2\n(4) Reference is made to Note 1 of Notes to Financial Statements in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1993, which Note is incorporated by reference herein, for the Company's policies in providing for depreciation, cost of timber harvested and amortization. The reconciliations of depreciation, cost of timber harvested and amortization, as shown above and on Schedule V, with the amounts in the statement of income follow:\n(5) For financial reporting purposes, property, plant and equipment are depreciated on the straight-line method over the estimated service lives of the individual assets as follows:\nLand improvements 2 to 20% Buildings 2 to 20% Machinery and equipment 3 to 33%\nLeasehold improvements are amortized over the shorter of the leases or estimated service lives.\nS-3\nSCHEDULE VIII\nCHAMPION INTERNATIONAL CORPORATION AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFor the Years Ended December 31, 1993 and 1992 (in thousands of dollars)\n- ----------------------- Note: (1) The deferred income tax valuation allowance primarily relates to general business credit carryforwards.\nS-4\nSCHEDULE IX\nCHAMPION INTERNATIONAL CORPORATION AND SUBSIDIARIES\nSHORT-TERM BORROWINGS\nFor the Years Ended December 31, 1993, 1992 and 1991 (in thousands of dollars)\n- ----------------------------------- Notes: (1) Variations in weighted average interest rates and in outstanding balances for 1993, 1992 and 1991 are attributable to book cash overdrafts. (2) Average amount of short-term borrowings is determined by utilizing the average month-end balances. (3) Weighted average interest rate for the year is determined by dividing average interest expense for the year by the average of month-end short-term borrowings for the year.\nS-5\nSCHEDULE X\nCHAMPION INTERNATIONAL CORPORATION AND SUBSIDIARIES\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFor the Years Ended December 31, 1993, 1992 and 1991 (in thousands of dollars)\nRoyalties, advertising costs, and amortization of intangible assets and pre- operating costs were not material.\nS-6\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo Champion International Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Champion International Corporation's 1993 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 17, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14(b) are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nARTHUR ANDERSEN & CO.\nNew York, N.Y. January 17, 1994\nS-7\nEXHIBIT INDEX\nEach Exhibit is listed according to the number assigned to it in the Exhibit Table of Item 601 of Regulation S-K. The Exhibit numbers preceded by an asterisk (*) indicate Exhibits physically filed with this Annual Report on Form 10-K. All other Exhibit numbers indicate Exhibits filed by incorporation by reference herein. Exhibit numbers 10.1 through 10.29, which are preceded by a plus sign (+), are management contracts or compensatory plans or arrangements.\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n3.1 Restated Certificate of Incorporation of the Company, filed in the State of New York on October 20, 1986 (filed by incorporation by reference to Exhibit 3.1 to the Company's Form 10-K for the fiscal year ended December 31, 1986, Commission File No. 1-3053).\n3.2 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on July 18, 1988 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n3.3 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 6, 1989 (filed by incorporation by reference to Exhibit 4.1 to the Company's Form 8-K dated December 14, 1989, Commission File No. 1-3053).\n3.4 Certificate of Amendment of Restated Certificate of Incorporation of the Company, filed in the State of New York on December 21, 1989 (filed by incorporation by reference to Exhibit 3.4 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n3.5 By-Laws of the Company (filed by incorporation by reference to Exhibit 3(ii).1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\n4.1 Letter agreement dated March 29, 1991 of the Company to furnish to the Commission upon request copies of certain instruments with respect to long-term debt (filed by incorporation by reference to Exhibit 4 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n4.2 Agreement dated February 2, 1994 between the Company and Loews Corporation (filed by incorporation by reference to Exhibit 4.7 to the Company's Registration Statement on Form S-3, Commission Registration No. 33-52123).\n+10.1 Champion International Corporation 1986 Management Incentive Program, consisting of the 1986 Stock Option Plan and the 1986 Contingent Compensation Plan (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1986, Commission File No. 1-3053).\n+10.2 Amendment to Champion International Corporation 1986 Management Incentive Program (filed by incorporation by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1993, Commission File No. 1-3053).\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n+10.3 Champion International Corporation Restricted Share Performance Plan, as amended (filed by incorporation by reference to Exhibit 10.2 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No.1-3053).\n+10.4 Champion International Corporation Management Incentive Program, as amended, consisting of the Amended 1976 Incentive Stock Option Plan and the Contingent Compensation Plan (filed by incorporation by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-8, Commission Registration No. 2-77129).\n+10.5 Resolutions of the Board of Directors of the Company adopted on August 16, 1984 amending the Amended 1976 Incentive Stock Option Plan (filed by incorporation by reference to Exhibit 10(b) to the Company's Registration Statement on Form S-14, Commission Registration No. 2-94030).\n+10.6 Champion International Corporation Supplemental Retirement Income Plan (filed by incorporation by reference to Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1989, Commission File No. 1-3053).\n+10.7 Supplemental Retirement and Death Payments Agreement dated as of August 1, 1964, as amended by letter agreement dated January 9, 1965, between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.8 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.8 Restated Agreement between the Company and Mr. Sigler, as amended as of February 19, 1987, providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.9 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 19.2 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.10 Amendment dated as of April 21, 1988 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 19.1 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\n+10.11 Amendment dated as of August 18, 1988 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.10 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.12 Amendment dated as of August 18, 1988 to Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Sigler (filed by incorporation by reference to Exhibit 10.11 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n+10.13 Amendment dated as of September 19, 1991 to Restated Agreement between the Company and Mr. Sigler as amended as of February 19, 1987 (filed by incorporation by reference to Exhibit 10.12 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.14 Agreement dated as of August 18, 1988 between the Company and Mr. Heist providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.15 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Heist providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.16 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Heist (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.17 Agreement dated as of October 18, 1990 between the Company and Mr. Nichols providing certain employment, severance and retirement arrangements (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.18 Agreement Relating to Legal Expenses dated October 18, 1990 between the Company and Mr. Nichols providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.17 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.19 Amendment dated as of September 19, 1991 to Agreement dated as of October 18, 1990 between the Company and Mr. Nichols (filed by incorporation by reference to Exhibit 10.18 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.20 Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.15 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.21 Agreement Relating to Legal Expenses dated February 19, 1987 between the Company and Mr. Burchfield providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.16 to the Company's Form 10-K for the fiscal year ended December 31, 1987, Commission File No. 1-3053).\n+10.22 Amendment dated as of April 21, 1988 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 19.5 to the Company's Form 10-Q for the quarter ended June 30, 1988, Commission File No. 1-3053).\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n+10.23 Amendment dated as of September 19, 1991 to Agreement dated as of February 19, 1987 between the Company and Mr. Burchfield (filed by incorporation by reference to Exhibit 10.22 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.24 Agreement dated as of August 18, 1988 between the Company and Mr. Olson providing certain severance arrangements (filed by incorporation by reference to Exhibit 10.23 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.25 Agreement Relating to Legal Expenses dated August 18, 1988 between the Company and Mr. Olson providing reimbursement of certain legal expenses following a change in control of the Company (filed by incorporation by reference to Exhibit 10.24 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n+10.26 Amendment dated as of September 19, 1991 to Agreement dated as of August 18, 1988 between the Company and Mr. Olson (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1991, Commission File No. 1-3053).\n+10.27 Trust Agreement dated as of February 19, 1987 between the Company and Connecticut National Bank securing certain payments under the contracts listed as Exhibit Numbers 10.8 through 10.26, among others, following a change in control of the Company (filed by incorporation by reference to Exhibit 19.11 to the Company's Form 10-Q for the quarter ended June 30, 1987, Commission File No. 1-3053).\n+10.28 Amendment dated as of August 18, 1988 to Trust Agreement dated as of February 19, 1987 between the Company and Connecticut National Bank (filed by incorporation by reference to Exhibit 10.29 to the Company's Form 10-K for the fiscal year ended December 31, 1988, Commission File No. 1-3053).\n+10.29 Champion International Corporation Executive Life Insurance Plan (filed by incorporation by reference to Exhibit 10.27 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n10.30 Extract from the minutes of the meeting of the Board of Directors of the Company held on October 18, 1979 relating to the $50,000 of group term life insurance provided by the Company for non-employee directors (filed by incorporation by reference to Exhibit 10.28 to the Company's Form 10-K for the fiscal year ended December 31, 1990, Commission File No. 1-3053).\n10.31 Resolutions of the Board of Directors of the Company adopted on September 19, 1991 relating to the compensation of directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1991, Commission File No. 1-3053).\n10.32 Retirement Plan for Outside Directors (filed by incorporation by reference to Exhibit 19 to the Company's Form 10-Q for the quarter ended September 30, 1992, Commission File No. 1-3053).\nEXHIBIT NUMBER DESCRIPTION - -------------- -----------\n*11 Schedule showing calculation of primary earnings per common share and fully diluted earnings per common share.\n*13 Portions of the Annual Report to Shareholders of Champion International Corporation for the fiscal year ended December 31, 1993 which are incorporated herein by reference.\n*21 List of significant subsidiaries of the Company.\n*23.1 Opinion and Consent of the Senior Vice President and General Counsel of the Company.\n*23.2 Consent of Arthur Andersen & Co.\n*24 Power of Attorney relating to the execution and filing of this Annual Report on Form 10-K and all amendments hereto.\n28:exhibt93.10k"},"word_count":{"kind":"number","value":9550,"string":"9,550"},"character_count":{"kind":"number","value":61540,"string":"61,540"}}}],"truncated":false,"partial":true},"paginationData":{"pageIndex":2,"numItemsPerPage":100,"numTotalItems":48543,"offset":200,"length":100}},"jwt":"eyJhbGciOiJFZERTQSJ9.eyJyZWFkIjp0cnVlLCJwZXJtaXNzaW9ucyI6eyJyZXBvLmNvbnRlbnQucmVhZCI6dHJ1ZX0sImlhdCI6MTc3NTg1MzU1Niwic3ViIjoiL2RhdGFzZXRzL1BsZUlBcy9TRUMiLCJleHAiOjE3NzU4NTcxNTYsImlzcyI6Imh0dHBzOi8vaHVnZ2luZ2ZhY2UuY28ifQ.mx2Pc526MW7j41w3cimhPGRlVqZFyvl24MKctuwNuLYwxRN_Il_Cveh-WWT0id4WVlx3MWBpFEz4uPg34KnpDw","displayUrls":true,"splitSizeSummaries":[{"config":"default","split":"train","numRows":48543,"numBytesParquet":2217781266}]},"discussionsStats":{"closed":0,"open":0,"total":0},"fullWidth":true,"hasGatedAccess":true,"hasFullAccess":true,"isEmbedded":false,"savedQueries":{"community":[{"views":[{"key":"default/train","displayName":"train","viewName":"train"}],"sql":"SELECT year, cik, SUBSTR(text, 1, 200) AS snippet FROM train WHERE cik = '320193' ORDER BY year LIMIT 5","title":"SQL Console for PleIAs/SEC","createdAt":"2026-03-18T19:29:41.121Z","slug":"Ev2907S","private":false,"justification":"Retrieves the first 200 characters of text documents for a specific company (CIK '320193') ordered by year, providing basic chronological access to company filings but offering minimal analytical insight.","viewNames":["train"]}],"user":[]}}">
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23752_1993.txt | 23752_1993 | 1993 | 23752 | null | 0 | 0 |
3153_1993.txt | 3153_1993 | 1993 | 3153 | ITEM 1. BUSINESS
SOUTHERN was incorporated under the laws of Delaware on November 9, 1945. SOUTHERN is domesticated under the laws of Georgia and is qualified to do business as a foreign corporation under the laws of Alabama. SOUTHERN owns all the outstanding common stock of ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVA... | 91,950 | 598,707 |
55454_1993.txt | 55454_1993 | 1993 | 55454 | ITEM 1. BUSINESS
1. General
Kerr Group, Inc. (the "Registrant"), a Delaware corporation which was founded in 1903, currently operates in two business segments: the Plastic Products segment and the Consumer Products segment.
Operations in the Plastic Products segment include the manufacture and sale of a variety of plas... | 4,533 | 29,135 |
40867_1993.txt | 40867_1993 | 1993 | 40867 | Item 1. Business
GTE North Incorporated (the Company) was incorporated in Wisconsin on January 27, 1987 and was the successor to the merger of eight telephone companies into the Company on March 31, 1987. All of the Common Stock of the Company was owned by GTE Corporation (GTE). Prior to March 31, 1993, the Company pro... | 4,689 | 30,991 |
51434_1993.txt | 51434_1993 | 1993 | 51434 | ITEM 1. BUSINESS
GENERAL
International Paper Company,* a New York corporation incorporated in 1941 as the successor to the New York corporation of the same name organized in 1898, is a worldwide producer of printing and writing papers, paperboard and packaging, wood products and distributes paper and office supply prod... | 6,775 | 46,515 |
894651_1993.txt | 894651_1993 | 1993 | 894651 | ITEM 1
Business ________
Introduction ____________
American Annuity Group, Inc. ("American Annuity", "AAG", or "the Company") is a holding company whose only significant asset is the capital stock of Great American Life Insurance Company ("GALIC"). American Annuity is the successor to STI Group, Inc., formerly known as... | 13,204 | 88,428 |
851945_1993.txt | 851945_1993 | 1993 | 851945 | Item 1. BUSINESS
Ogden Projects, Inc. and its subsidiaries (the "Company") provide waste disposal services throughout the United States. Its principal business, conducted through wholly-owned subsidiaries, including Ogden Martin Systems, Inc. ("OMS"), is providing waste-to-energy services. Waste-to- energy facilities c... | 12,443 | 83,186 |
833890_1993.txt | 833890_1993 | 1993 | 833890 | ITEM 1. BUSINESS
Ashland Coal, Inc. (Ashland Coal or the Company) is engaged in the mining, processing, marketing and distribution of low-sulfur bituminous coal. The Company sells its coal primarily to electric utilities in the eastern United States. The Company also exports coal, primarily to European customers. Ashla... | 15,347 | 99,687 |
92122_1993.txt | 92122_1993 | 1993 | 92122 | ITEM 1. BUSINESS
SOUTHERN was incorporated under the laws of Delaware on November 9, 1945. SOUTHERN is domesticated under the laws of Georgia and is qualified to do business as a foreign corporation under the laws of Alabama. SOUTHERN owns all the outstanding common stock of ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVA... | 91,950 | 598,707 |
91882_1993.txt | 91882_1993 | 1993 | 91882 | ITEM 1. BUSINESS
THE COMPANY
Organization
The Company, a wholly owned subsidiary of SCANA, is a South Carolina corporation organized in 1924 and has its principal executive office at 1426 Main Street, Columbia, South Carolina 29201, telephone number (803) 748-3000. The Company had 4,166 full-time, permanent employees a... | 36,507 | 236,905 |
832427_1993.txt | 832427_1993 | 1993 | 832427 | Item 1. DESCRIPTION OF BUSINESS
National Health Laboratories Incorporated (the "Company") was incorporated in Delaware on March 23, 1971 as DCL Health Laboratories Incorporated and adopted its current name on June 3, 1974. The Company's principal executive offices are located at 4225 Executive Square, Suite 800, La Jol... | 18,575 | 122,716 |
825313_1993.txt | 825313_1993 | 1993 | 825313 | ITEM 1. BUSINESS
General The Partnership was formed in 1987 to succeed to the business of ACMC which began providing investment management services in 1971. On April 21, 1988 the business and substantially all of the operating assets of ACMC were conveyed to the Partnership in exchange for a 1% general partnership inte... | 18,293 | 119,255 |
30875_1993.txt | 30875_1993 | 1993 | 30875 | ITEM 1. BUSINESS
The Company was incorporated in Delaware in 1964. The Company designs, develops and produces advanced electronic systems and products, primarily for sale in defense related markets, and provides various related technical services. The Company's largest business segments are the design, development and ... | 12,101 | 81,432 |
821020_1993.txt | 821020_1993 | 1993 | 821020 | ITEM 1. BUSINESS. 1.(A) GENERAL
Heritage Media Corporation (the "Company", "Heritage", or "HMC"), through its ACTMEDIA, Inc. ("ACTMEDIA") subsidiary, is the world's largest independent provider of in-store marketing products and services, primarily to consumer packaged goods manufacturers with products in supermarkets ... | 21,134 | 139,610 |
846972_1993.txt | 846972_1993 | 1993 | 846972 | Item 1. Business
Adience, Inc. ("Adience," and together with its subsidiaries, the "Company") is engaged in the manufacture, sale, installation and maintenance of specialty refractory products through its Heat Technology Division. Refractory products, which are made primarily from fireclays and minerals such as bauxiti... | 22,562 | 149,858 |
96966_1993.txt | 96966_1993 | 1993 | 96966 | ITEM 1. BUSINESS
Telephone and Data Systems, Inc. (the "Company" or "TDS"), is a diversified telecommunications service company with local telephone, cellular telephone and radio paging operations. At December 31, 1993, the Company operated 94 telephone subsidiaries serving 356,200 access lines in rural and suburban ar... | 20,362 | 139,485 |
100880_1993.txt | 100880_1993 | 1993 | 100880 | ITEM 3 - LEGAL PROCEEDINGS
( 1 ) The company may face potentially significant financial exposure from possible civil penalty citations, claims and lawsuits regarding environmental matters. These matters include, for example, properties requiring presently undeterminable amounts of cleanup efforts and expenses, soil or ... | 11,612 | 76,500 |
810765_1993.txt | 810765_1993 | 1993 | 810765 | Item 1. Business. - ------ -------- GENERAL. Consolidated Rail Corporation ("the Company") is a ------- Pennsylvania corporation incorporated on February 10, 1976 to acquire, pursuant to the Regional Rail Reorganization Act of 1973, the rail properties of many of the railroads in the northeast and midwest region of the... | 12,281 | 81,708 |
216539_1993.txt | 216539_1993 | 1993 | 216539 | Item 1. Business
General
For a general description of the Company's business, see Business in Brief on page 4 of the 1993 Annual Report to Stockholders, which is incorporated herein by reference. The Company employs approximately 7,300 people on a full or part-time basis. The Company's businesses are somewhat cyclical;... | 5,707 | 37,066 |
850033_1993.txt | 850033_1993 | 1993 | 850033 | ITEM 1. BUSINESS
DESCRIPTION OF THE TRUST
BP Prudhoe Bay Royalty Trust (the "Trust"), a grantor trust, was created as a Delaware business trust. The Trust has been established by The Standard Oil Company ("Standard Oil") and is administered by The Bank of New York, as trustee (collectively with the co-trustee located i... | 23,865 | 147,189 |
36966_1993.txt | 36966_1993 | 1993 | 36966 | ITEM 1 BUSINESS
General.
First Tennessee National Corporation (the "Corporation") is a Tennessee corporation incorporated in 1968 and registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. At December 31, 1993, the Corporation had total assets of $9.6 billion and ranked first in te... | 7,023 | 46,121 |
856716_1993.txt | 856716_1993 | 1993 | 856716 | ITEM 3. LEGAL PROCEEDINGS
Toca
On March 4, 1993, the Company filed a complaint against Warren Petroleum Company, Arco Oil & Gas Co., Conoco Inc., Trident NGL, Inc. and other owners of the Yscloskey Gas Plant located in Louisiana (the "Owners") in the United States District Court for the Eastern District of Louisiana, a... | 18,326 | 119,134 |
49071_1993.txt | 49071_1993 | 1993 | 49071 | ITEM 1. BUSINESS
GENERAL
Humana Inc. is a Delaware corporation organized in 1961. Its principal executive offices are located at 500 West Main Street, Louisville, Kentucky 40202, and its telephone number at that address is (502) 580-1000. As used herein, the term "the Company" includes Humana Inc. and its subsidiaries.... | 6,069 | 40,326 |
351616_1993.txt | 351616_1993 | 1993 | 351616 | Item 1. Business
ONE VALLEY BANCORP OF WEST VIRGINIA, INC.
The Board of Directors of One Valley Bank, National Association, formerly Kanawha Valley Bank, National Association ("One Valley Bank"), caused One Valley Bancorp of West Virginia, Inc. ("One Valley"), a West Virginia corporation, to be formed, through a corpor... | 7,641 | 49,261 |
789575_1993.txt | 789575_1993 | 1993 | 789575 | Item 1. Business - ----------------- Grenada Sunburst System Corporation (the "Registrant") is a multi-bank holding company headquartered in Grenada, Mississippi. The Registrant was organized under the laws of the state of Delaware on May 20, 1986. The Registrant has two major subsidiaries: Sunburst Bank, Mississippi, ... | 2,411 | 16,869 |
104938_1993.txt | 104938_1993 | 1993 | 104938 | ITEM 1. BUSINESS.
GENERAL
WMX Technologies, Inc. (formerly named Waste Management, Inc.) is a leading international provider of environmental, engineering and construction, industrial and related services. Unless the context indicates to the contrary, as used in this report the terms "Company" and "WMX Technologies" re... | 7,555 | 53,049 |
811669_1993.txt | 811669_1993 | 1993 | 811669 | ITEM 1 -- BUSINESS
GENERAL
UST Inc. was formed on December 23, 1986 as a Delaware corporation. Pursuant to a reorganization approved by stockholders at the 1987 Annual Meeting, United States Tobacco Company (originally incorporated in 1911) became a wholly owned subsidiary of UST Inc. on May 5, 1987. UST Inc., through ... | 4,075 | 28,648 |
29332_1993.txt | 29332_1993 | 1993 | 29332 | ITEM 1. BUSINESS
GENERAL
An integral part of the Company's strategy during the past two years has been to restructure its operations and expand into floorcovering. Today, the Company operates in two business segments - Textile products and Floorcovering - with approximately half of its sales in each segment. Prior to t... | 12,392 | 83,562 |
88128_1993.txt | 88128_1993 | 1993 | 88128 | Item 3. Legal Proceedings.
In December 1993, a Consent Decree was entered in the U. S. District Court in Jacksonville, Florida to settle claims of Federal Clean Water Act violations alleged against CSXT. The Consent Decree resolves a civil enforcement action initiated in June, 1992, by the U.S. Environmental Protection... | 10,306 | 66,770 |
277821_1993.txt | 277821_1993 | 1993 | 277821 | ITEM 1. BUSINESS.
GENERAL DEVELOPMENT OF THE COMPANY'S BUSINESS
National Education Corporation (the "Company") provides training and education to individuals, businesses and governments. The Company was originally incorporated in California in 1954 and reincorporated in Delaware in 1972. Its business is conducted throu... | 8,587 | 59,466 |
18672_1993.txt | 18672_1993 | 1993 | 18672 | ITEM 1. BUSINESS
GENERAL
Central Louisiana Electric Company, Inc. (the Company) was incorporated in 1934 under the laws of the State of Louisiana and is engaged principally in the generation, transmission, distribution and sale of electric energy to approximately 213,000 customers in 63 communities and contiguous rural... | 4,004 | 25,401 |
831964_1993.txt | 831964_1993 | 1993 | 831964 | ITEM 3. LEGAL PROCEEDINGS
The Company recently settled litigation with Diamond M concerning various matters relating to the sale and bareboat charter of 3 offshore drilling rigs. Legal proceedings were instituted by the
Company on August 29, 1991, and were consolidated with related legal proceedings subsequently instit... | 13,415 | 86,523 |
737291_1993.txt | 737291_1993 | 1993 | 737291 | ITEM 1. BUSINESS
Unless otherwise indicated, all references to "Notes" are to Notes to Consolidated Financial Statements contained in this report.
The registrant, Carlyle Real Estate Limited Partnership-XIV (the "Partnership"), is a limited partnership formed in late 1983 and currently governed by the Revised Uniform L... | 118,505 | 734,801 |
92244_1993.txt | 92244_1993 | 1993 | 92244 | Item 1. Business
GENERAL
The Southern New England Telephone Company ("Telephone Company") was incorporated in 1882 under the laws of the State of Connecticut and has its principal executive offices at 227 Church Street, New Haven, Connecticut 06510 (telephone number (203) 771-5200). The Telephone Company is a wholly ow... | 14,446 | 95,138 |
808369_1993.txt | 808369_1993 | 1993 | 808369 | ITEM 1. BUSINESS
General. The registrant, ML/EQ Real Estate Portfolio, L.P. (the "Partnership"), is a limited partnership formed on December 2, 1986 under the Revised Uniform Limited Partnership Act of the State of Delaware.
The Partnership's two general partners are EREIM Managers Corp., a Delaware corporation (the "M... | 13,580 | 87,428 |
29917_1993.txt | 29917_1993 | 1993 | 29917 | ITEM 1. BUSINESS - -----------------
Dow Corning Corporation (Dow Corning or the Company) was incorporated in 1943 by Corning Glass Works (now Corning Incorporated) and The Dow Chemical Company (Dow Chemical) to develop, produce and market silicones. Corning Incorporated provided the basic silicone technology and Dow C... | 16,108 | 108,733 |
34879_1993.txt | 34879_1993 | 1993 | 34879 | ITEM 1. BUSINESS
Overview - - - --------
Federal-Mogul Corporation (which together with its consolidated subsidiaries is referred to herein as "Federal-Mogul", the "Company" or "Registrant") is a global distributor and manufacturer of a broad range of non-discretionary parts, primarily vehicular components for automobi... | 18,936 | 127,421 |
314890_1993.txt | 314890_1993 | 1993 | 314890 | Item 1. BUSINESS
(a) General Development of Business
WICOR, Inc. (the "Company" or "WICOR") is a diversified holding company with two principal businesses: natural gas distribution and manufacturing of pumps and water processing equipment. Wisconsin Gas Company ("Wisconsin Gas") engages in retail distribution of natura... | 8,047 | 52,984 |
847903_1993.txt | 847903_1993 | 1993 | 847903 | ITEM 1. BUSINESS
(a) General Development of Business
RJR Nabisco Holdings Corp. ("Holdings") was organized as a Delaware corporation in 1988 at the direction of Kohlberg Kravis Roberts & Co., L.P. ("KKR"), a Delaware limited partnership, to effect the acquisition of RJR Nabisco, Inc. ("RJRN"), which was completed on Ap... | 25,785 | 171,001 |
46216_1993.txt | 46216_1993 | 1993 | 46216 | Item 1. Business
GTE Hawaiian Telephone Company Incorporated (the Company) (formerly Hawaiian Telephone Company) was incorporated under the laws of the Kingdom of Hawaii in 1883. The Company is a wholly-owned subsidiary of GTE Corporation (GTE) and provides communications services in Hawaii and throughout the Pacific a... | 2,312 | 15,895 |
96638_1993.txt | 96638_1993 | 1993 | 96638 | ITEM 1. BUSINESS.
OVERVIEW
Advanta Corp. (the "Company") is a highly focused direct marketer of select consumer financial services. The Company primarily originates and services credit cards and mortgage loans. Other businesses include small ticket equipment leasing, credit insurance and deposit products. At year end 1... | 22,644 | 148,490 |
890539_1993.txt | 890539_1993 | 1993 | 890539 | ITEM 1. BUSINESS
Each of the Grantor Trusts, (the "Trusts"), listed below, was formed by GMAC Auto Receivables Corporation (the "Seller") by selling and assigning the receivables and the security interests in the vehicles financed thereby to The First National Bank of Chicago, as Trustee, in exchange for Class A certif... | 12,726 | 88,298 |
790159_1993.txt | 790159_1993 | 1993 | 790159 | ITEM 1 -- BUSINESS
GENERAL
Wheelabrator Technologies Inc. provides a wide array of environmental products and services in North America and abroad through three principal business lines. The Company's energy group ("Wheelabrator Clean Energy") is a leading developer of facilities and systems for, and provider of servic... | 4,945 | 32,262 |
101829_1993.txt | 101829_1993 | 1993 | 101829 | Item 1. Business
History of Business
United Technologies Corporation was incorporated in Delaware in 1934. Since 1973, growth has been enhanced by the acquisition of several companies and by internal growth of existing businesses of the Corporation*.
In the first quarter of 1988, the Corporation sold its Essex Group. I... | 12,364 | 82,740 |
18926_1993.txt | 18926_1993 | 1993 | 18926 | Item 1. Business.
Century Telephone Enterprises, Inc. ("Century") is a regional
diversified telecommuni-cations company that is primarily engaged
in providing traditional telephone services and mobile
communications services. For the year ended December 31, 1993,
telephone operations and mobile communications operation... | 25,671 | 184,030 |
751976_1993.txt | 751976_1993 | 1993 | 751976 | ITEM 1. BUSINESS
INTRODUCTION
The Newhall Land and Farming Company (a California Limited Partnership) ("the Company" or "the Partnership") is engaged in the development of residential, industrial and commercial real estate and in agriculture and is one of California's largest land resource companies. The interests in t... | 21,153 | 137,875 |
850143_1993.txt | 850143_1993 | 1993 | 850143 | ITEM 1. BUSINESS
Development and Description of Business --------------------------------------- Information concerning the business of CRI Liquidating REIT, Inc. (the Liquidating Company) is contained in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and in Note... | 12,645 | 84,477 |
37637_1993.txt | 37637_1993 | 1993 | 37637 | ITEM 1. BUSINESS
THE COMPANY
Florida Power Corporation (the "Company") was incorporated in Florida in 1899 and is an operating public utility engaged in the generation, purchase, transmission, distribution and sale of electricity within Florida. The Company became a wholly owned subsidiary of Florida Progress Corporati... | 20,159 | 135,751 |
897729_1993.txt | 897729_1993 | 1993 | 897729 | ITEM 1. BUSINESS.
(a) General Development of Business
Trump Plaza Associates (the "Partnership") owns and operates the Trump Plaza Hotel and Casino ("Trump Plaza"), a luxury casino hotel located on The Boardwalk in Atlantic City, New Jersey. The Partnership was organized in June 1982 as a general partnership under the ... | 34,678 | 222,883 |
46738_1993.txt | 46738_1993 | 1993 | 46738 | ITEM 1. BUSINESS
Heller Financial, Inc. (the "Company") was incorporated in 1919 under the laws of the State of Delaware and is engaged in various aspects of the commercial finance business. The Company and its consolidated subsidiaries employ approximately 1,400 people. The executive offices of the Company are located... | 18,445 | 122,615 |
69970_1993.txt | 69970_1993 | 1993 | 69970 | Item 12. Security Ownership of Certain Beneficial Owners and Management; and Item 13. | 13 | 85 |
86940_1993.txt | 86940_1993 | 1993 | 86940 | ITEM 1. BUSINESS
SOUTHERN was incorporated under the laws of Delaware on November 9, 1945. SOUTHERN is domesticated under the laws of Georgia and is qualified to do business as a foreign corporation under the laws of Alabama. SOUTHERN owns all the outstanding common stock of ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVA... | 91,950 | 598,707 |
64907_1993.txt | 64907_1993 | 1993 | 64907 | ITEM 2. PROPERTIES
Mercantile and Mercantile Bank occupy 22 stories of the Mercantile Tower, a 35-story building owned by Mercantile Bank and located at Seventh and Washington Streets in St. Louis, Missouri. Among the other properties owned by Mercantile Bank are a four story, 91,170 usable square foot off-site office ... | 906 | 6,004 |
39547_1993.txt | 39547_1993 | 1993 | 39547 | ITEM 1. BUSINESS.
The Actava Group Inc. ("Actava" or the "Company") provides high quality, brand-name products through distribution channels to retail markets across the United States. Actava operates in three distinct businesses: photofinishing, lawn and garden equipment and sporting goods. A description of each segme... | 22,504 | 148,136 |
823549_1993.txt | 823549_1993 | 1993 | 823549 | ITEM 1. BUSINESS.
Tenneco Inc., a Delaware corporation, is a diversified industrial company conducting all of its operations through its subsidiaries. As used herein, "Tenneco" refers to Tenneco Inc. and its consolidated subsidiaries.
The major businesses of Tenneco are the transportation and sale of natural gas; manuf... | 29,741 | 198,286 |
7383_1993.txt | 7383_1993 | 1993 | 7383 | ITEM 1. BUSINESS
General
Armco Inc. ("Armco" or the "Company") was incorporated as an Ohio corporation in 1917 as a successor to a New Jersey corporation incorporated in 1899. Armco is the second largest domestic producer of stainless flat-rolled steels and is the largest domestic producer of electrical steels in terms... | 27,311 | 180,933 |
792014_1993.txt | 792014_1993 | 1993 | 792014 | Item 1. Business. Introduction
INVG Mortgage Securities Corp. (the "Company") is a corporation organized under the laws of the State of Maryland on March 26, 1986. The Company's principal executive offices are located at Meadow Wood Crown Plaza, 1575 Delucchi Lane, Suite 115-20, Reno, Nevada 89502. Its telephone number... | 14,920 | 94,943 |
791445_1993.txt | 791445_1993 | 1993 | 791445 | ITEM 1. BUSINESS.
(a) General Development of Business
Trump Plaza Associates (the "Partnership") owns and operates the Trump Plaza Hotel and Casino ("Trump Plaza"), a luxury casino hotel located on The Boardwalk in Atlantic City, New Jersey. The Partnership was organized in June 1982 as a general partnership under the ... | 34,678 | 222,883 |
9534_1993.txt | 9534_1993 | 1993 | 9534 | ITEM 1. BUSINESS
All references herein to the "Corporation" or "Bandag" refer to Bandag, Incorporated and its subsidiaries unless the context indicates otherwise.
Bandag is engaged in the production and sale of precured tread rubber and equipment used by its franchisees for the retreading of tires for trucks, buses, li... | 10,013 | 65,570 |
813461_1993.txt | 813461_1993 | 1993 | 813461 | ITEM 1 -- BUSINESS
GENERAL
Westcorp, a California corporation, is a financial services holding company which operates principally through its wholly-owned subsidiary, Western Financial Savings Bank, F.S.B. (the "Bank"). The Bank owns all of the outstanding capital stock of Westcorp Financial Services, Inc. ("Westcorp F... | 31,618 | 206,180 |
774459_1993.txt | 774459_1993 | 1993 | 774459 | ITEM 1. BUSINESS
Allegheny Power System, Inc. (APS), incorporated in Maryland in 1925, is an electric utility holding company that derives substantially all of its income from the electric utility operations of its direct and indirect subsidiaries (Subsidiaries), Monongahela Power Company (Monongahela), The Potomac Edi... | 70,402 | 448,419 |
23675_1993.txt | 23675_1993 | 1993 | 23675 | ITEM 1. BUSINESS
(a) General Development of Business - -----------------------------------
Consolidated Freightways, Inc. is a holding company which participates through subsidiaries in various forms of long-haul and regional trucking, intermodal rail and ocean services, domestic and international air cargo delivery se... | 7,542 | 50,738 |
357301_1993.txt | 357301_1993 | 1993 | 357301 | Item 1. Business
General
TrustCo Bank Corp NY ("TrustCo") is a one-bank holding company having its principal place of business at 320 State Street, Schenectady, New York 12305. TrustCo Bank Corp NYwas organized in 1981 to acquire all of the outstanding stock of Trustco Bank New York, formerly known as The Schenectady T... | 38,825 | 246,121 |
850693_1993.txt | 850693_1993 | 1993 | 850693 | ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Allergan, Inc. ("Allergan" or the "Company") is a global provider of specialty therapeutic products principally in the areas of eye and skin care. Its worldwide consolidated revenues are generated by prescription and non-prescription pharmaceutical products in the areas ... | 6,404 | 42,925 |
746838_1993.txt | 746838_1993 | 1993 | 746838 | ITEM 1. BUSINESS - -----------------
Unisys Corporation ("Unisys") provides information services, technology and software on a worldwide basis.
Unisys operates primarily in one business segment: information management systems and related services and supplies. This segment represents more than 90% of consolidated reven... | 5,418 | 36,625 |
714560_1993.txt | 714560_1993 | 1993 | 714560 | Item 1. BUSINESS
USAir Group, Inc. ("USAir Group" or the "Company") is a corporation organized under the laws of the State of Delaware. The Company's executive offices are located at 2345 Crystal Drive, Arlington, Virginia 22227 (telephone number (703) 418-5306). USAir Group's primary business activity is ownership of ... | 107,749 | 686,513 |
33213_1993.txt | 33213_1993 | 1993 | 33213 | Item 1. Business
(a)Equitable Resources, Inc. ("Equitable" or the "Company") was formed under the laws of Pennsylvania by the consolidation and merger in 1925 of two constituent companies, the older of which was organized in 1888. The Company owns all the capital stock of subsidiary companies. Principal subsidiaries ar... | 14,925 | 96,322 |
791024_1993.txt | 791024_1993 | 1993 | 791024 | ITEM 1 -- BUSINESS
GENERAL
Home Shopping Network, Inc. ("HSN" or the "Company") is a holding company, the subsidiaries of which conduct the day-to-day operations of the Company's various business activities. The Company's primary business, and principal source of revenue, is electronic retail sales by Home Shopping Clu... | 13,066 | 85,048 |
96238_1993.txt | 96238_1993 | 1993 | 96238 | Item 1. Business.
(a) Developments since January 1, 1993.
On October 22, 1993 Talley Industries, Inc. (herein referred to as either "Talley" or the "Company" or the "Registrant") completed a major debt refinancing program by issuing Senior Notes and Senior Discount Debentures, and by securing a credit facility with two... | 24,511 | 163,285 |
704386_1993.txt | 704386_1993 | 1993 | 704386 | ITEM 1. BUSINESS
VLSI Technology, Inc., a Delaware corporation ("VLSI" or the "Company"), was incorporated in May 1987 as a successor to the business of VLSI Technology, Inc., a California corporation, ("VLSI-California"). The merger of VLSI-California with and into the Company was consummated on December 31, 1987. All... | 18,987 | 128,052 |
350572_1993.txt | 350572_1993 | 1993 | 350572 | ITEM 1. BUSINESS.
GENERAL
Worthen Banking Corporation (hereinafter referred to as "WBC", "Company" or "Registrant" and includes WBC's subsidiaries and affiliates unless the context otherwise requires), was incorporated in the State of Arkansas in August 1968 to buy, sell, own and operate banks and to offer a diversifie... | 7,230 | 47,311 |
11199_1993.txt | 11199_1993 | 1993 | 11199 | ITEM 1 - BUSINESS
Bemis Company, Inc., a Missouri corporation, continues a business formed in 1858. The Registrant was incorporated in 1885 as Bemis Bro. Bag Company with the name changed to Bemis Company, Inc. in 1965.
The Registrant is a principal manufacturer of flexible packaging products and specialty coated and g... | 2,371 | 15,630 |
44801_1993.txt | 44801_1993 | 1993 | 44801 | ITEM 1. BUSINESS
GENERAL
Hadson Corporation, a Delaware corporation (the "Company"), is engaged, through its consolidated subsidiaries, in providing energy products and services, consisting of the purchasing, gathering, processing, storing and transporting of natural gas and natural gas liquids ("NGLs"), as well as the... | 23,514 | 151,562 |
814677_1993.txt | 814677_1993 | 1993 | 814677 | ITEM 1. BUSINESS.
A. Introduction
(i) Background.
PLM International, Inc. ("PLM International" or the "Company" or "PLMI"), a Delaware corporation, is a transportation equipment leasing company specializing in the management of equipment on operating leases domestically and internationally. The Company is also the lead... | 16,465 | 108,763 |
869844_1993.txt | 869844_1993 | 1993 | 869844 | Item 1. Business
The Sears Credit Account Trust 1990 E (the "Trust") was formed pursuant to the Pooling and Servicing Agreement dated as of December 1, 1990 (the "Pooling and Servicing Agreement") among Sears, Roebuck and Co. ("Sears") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. ("... | 1,492 | 10,239 |
745448_1993.txt | 745448_1993 | 1993 | 745448 | ITEM 1. BUSINESS.
MascoTech, Inc. (formerly Masco Industries, Inc.) is a diversified manufacturer of original equipment and aftermarket parts for the transportation industry; commercial, institutional and residential building products for the construction industry; and other diversified products principally for the def... | 17,559 | 119,839 |
840251_1993.txt | 840251_1993 | 1993 | 840251 | Item 3. Legal Proceedings.
East Line Litigation and FERC Proceeding: In August 1992, two East Line refiners, Navajo Refining Company ("Navajo") and El Paso Refinery, L.P. ("El Paso") and its general partner, El Paso Refining, Inc., filed separate, though similar, lawsuits against the Partnership in New Mexico an... | 14,194 | 102,185 |
811671_1993.txt | 811671_1993 | 1993 | 811671 | Item 1 - Business
Sterling Financial Corporation
Sterling Financial Corporation (the "Corporation") is a Pennsylvania business corporation, based in Lancaster, Pennsylvania, which was organized on February 23, 1987 and became a bank holding company through the acquisition of all the outstanding stock of The First Natio... | 9,911 | 63,788 |
723916_1993.txt | 723916_1993 | 1993 | 723916 | ITEM 1.
Meridian Bancorp, Inc.
Meridian Bancorp, Inc. (the "Registrant"), a multi-bank holding company registered under the federal Bank Holding Company Act of 1956, as amended, was incorporated as a Pennsylvania business corporation as a result of the statutory consolidation on June 30, 1983 of American Bancorp, Inc. ... | 30,483 | 201,128 |
40211_1993.txt | 40211_1993 | 1993 | 40211 | Item 1. Business
GATX Corporation is a holding company whose subsidiaries engage in the leasing and management of railroad tank cars and specialized freight cars; provide equipment and capital asset financing and related services; own and operate tank storage terminals, pipelines and related facilities; engage in Great... | 6,307 | 41,577 |
27673_1993.txt | 27673_1993 | 1993 | 27673 | ITEM 1. BUSINESS.
THE COMPANY
The principal business of John Deere Capital Corporation (Capital Corporation) is the purchasing and financing of retail installment sales and loan contracts (retail notes) from the equipment sales branches in the United States operated by Deere & Company and its wholly-owned subsidiaries ... | 16,470 | 106,300 |
79209_1993.txt | 79209_1993 | 1993 | 79209 | ITEM 1. BUSINESS.
PLY GEM Industries, Inc., a Delaware corporation ("Ply Gem", hereinafter with its subsidiaries referred to collectively as the "Company"), was originally incorporated in 1946 in New York and reincorporated in Delaware in 1987. The Company is a leading manufacturer and distributor of a wide range of sp... | 9,229 | 61,002 |
860004_1993.txt | 860004_1993 | 1993 | 860004 | Item 1. Business
The Sears Credit Account Trust 1990 B (the "Trust") was formed pursuant to the Pooling and Servicing Agreement dated as of February 22, 1990 (the "Pooling and Servicing Agreement") among Sears, Roebuck and Co. ("Sears") as Servicer, its wholly-owned subsidiary, Sears Receivables Financing Group, Inc. (... | 1,445 | 9,914 |
275177_1993.txt | 275177_1993 | 1993 | 275177 | Item 1. Business - -------- Carolina Telephone and Telegraph Company (the Company), a wholly-owned subsidiary of Sprint Corporation (Sprint), was incorporated under the laws of the State of North Carolina in 1968, and in 1969 acquired all of the public utility assets of the predecessor company of the same name pursuant... | 11,591 | 80,457 |
31277_1993.txt | 31277_1993 | 1993 | 31277 | Item 1. Business
Eaton Corporation (herein referred to as Eaton or Company) was incorporated in 1916. Eaton is a global manufacturer of vehicle powertrain components and a broad variety of controls serving transportation, industrial, commercial, aerospace, and military markets. The Company offers thousands of high-qual... | 13,622 | 89,355 |
799036_1993.txt | 799036_1993 | 1993 | 799036 | Item 1. Business
GENERAL
The Company, through its subsidiaries, provides health and life insurance underwriting, marketing and managed healthcare services throughout the nation.
In 1993 the Company was organized into three Business Divisions: Insurance (Life & Health Units), Marketing and Managed Care. The Divisions we... | 57,688 | 358,318 |
7332_1993.txt | 7332_1993 | 1993 | 7332 | ITEM 1. BUSINESS Southwestern Energy Company (the Company) is a diversified natural gas company which conducts its primary activities through four wholly owned subsidiaries. The Company operates principally in the exploration and production segment and the gas distribution segment of the natural gas industry. The Compa... | 9,169 | 59,648 |
47111_1993.txt | 47111_1993 | 1993 | 47111 | Item 1.BUSINESS
Hershey Foods Corporation and its subsidiaries (the "Corporation") are engaged in the manufacture, distribution and sale of consumer food products. The Corporation, primarily through its Hershey Chocolate U.S.A., Hershey Grocery, Hershey International and Hershey Pasta Group divisions and its subsidiary... | 5,288 | 35,559 |
764625_1993.txt | 764625_1993 | 1993 | 764625 | ITEM 1. Business
Enserch Exploration Partners, Ltd. ("EP"), a Texas limited partnership, was formed in 1985 to succeed to substantially all of the domestic gas and oil exploration and production business of ENSERCH Corporation ("ENSERCH"). ENSERCH and an affiliate own more than 99% of the outstanding limited partnershi... | 9,931 | 62,095 |
201533_1993.txt | 201533_1993 | 1993 | 201533 | ITEM 1. BUSINESS.
GENERAL
CMS Energy
CMS Energy, incorporated in Michigan in 1987, is the parent holding company of Consumers and Enterprises. Consumers, a combination electric and gas utility company serving most of the Lower Peninsula of Michigan, is the largest subsidiary of CMS Energy. Consumers' customer base incl... | 48,450 | 317,717 |
1800_1993.txt | 1800_1993 | 1993 | 1800 | ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Abbott Laboratories is an Illinois corporation, incorporated in 1900. The Company's* principal business is the discovery, development, manufacture, and sale of a broad and diversified line of health care products and services.
FINANCIAL INFORMATION RELATING TO INDUSTRY S... | 6,121 | 42,451 |
20762_1993.txt | 20762_1993 | 1993 | 20762 | ITEM 1 AND 2. BUSINESS; PROPERTIES
Clark Refining & Marketing, Inc. (formerly known as Clark Oil & Refining Corporation), a Delaware Corporation (the "Company" or "Clark"), headquartered in St. Louis, Missouri, is one of the leading independent refiners and marketers of petroleum products in the Midwest. Its principal ... | 17,699 | 114,628 |
4829_1993.txt | 4829_1993 | 1993 | 4829 | Item 1. Business. GENERAL
American Cyanamid Company, a Maine corporation organized in 1907, is a research-based life sciences company which, together with its subsidiaries (collectively "Cyanamid"), discovers and develops medical and agricultural products, and manufactures and markets them throughout the world. Cyanami... | 7,542 | 49,565 |
720695_1993.txt | 720695_1993 | 1993 | 720695 | ITEM 1. BUSINESS
GENERAL
Pathe Communications Corporation (the "Company") is a Delaware corporation with no operating assets or sources of operating income and total liabilities exceeding $269,000,000. The Company is wholly dependent upon Credit Lyonnais Bank Nederland N.V., a Dutch banking institution ("CLBN"), for al... | 17,996 | 115,331 |
311100_1993.txt | 311100_1993 | 1993 | 311100 | Item 1. Business
Incorporated herein by reference is the information appearing under the heading "Business of Jefferson Bankshares" on page 4 of the 1993 Annual Report to Shareholders ("1993 Annual Report"). Also incorporated herein by reference is the information on pages 7 through 10 of the 1993 Annual Report as to t... | 2,175 | 14,069 |
39677_1993.txt | 39677_1993 | 1993 | 39677 | Item 1. Business
Avatar Holdings Inc. (a Delaware corporation incorporated in 1970) and its subsidiaries (collectively, "Avatar" or the "Company") are engaged in two principal business activities: real estate and water and wastewater utilities operations. Avatar's real estate operations, which are located in the states... | 13,298 | 87,375 |
60519_1993.txt | 60519_1993 | 1993 | 60519 | ITEM 1. Business
General
Louisiana-Pacific Corporation, a Delaware corporation, is a major forest products firm headquartered in Portland, Oregon. It manufactures lumber, pulp, structural and other panel products, hardwood veneers, windows and doors and cellulose insulation. It operates 129 plants and mills in 27 U.S. ... | 9,245 | 60,911 |
10427_1993.txt | 10427_1993 | 1993 | 10427 | ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
Bausch & Lomb Incorporated is a world leader in the development, manufacture and marketing of products and services for the personal health, medical, biomedical and optics fields.
Bausch & Lomb was incorporated in the State of New York in 1908 to carry on a business ... | 11,175 | 71,798 |
63276_1993.txt | 63276_1993 | 1993 | 63276 | Item 1. Business - ------- --------
The Company designs, develops, manufactures, markets and distributes a broad variety of toy products on a worldwide basis. Measured by revenues, the Company is the second largest toy company in the world. The Company's three strongest principal product lines are BARBIE fashion dolls ... | 9,010 | 60,125 |
19150_1993.txt | 19150_1993 | 1993 | 19150 | ITEM 1. BUSINESS
GENERAL
Champion International Corporation was incorporated under the laws of the State of New York on April 28, 1937. References to the "Company" include Champion International Corporation and its subsidiaries at December 31, 1993, unless the context otherwise requires.
The Company is one of the leadi... | 9,550 | 61,540 |
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